Ladies and Gentlemen,
1. It is a great pleasure for me to open the proceedings of this
conference on "The Euro: Lessons for European and Asian Financial
Markets". It is also an honour for the Hong Kong Monetary Authority
to be co-sponsoring this event with the European Commission. The
programme is a very rich one and it will be impossible for me, in
these opening remarks, to cover all the topics to be discussed
later this morning and in the afternoon. I do notice, however, that
the words "financial integration and regulation" appear in several
of the session titles. These are topics close to my heart, because
I have come to believe that they can influence profoundly how Asian
economies develop in the years ahead. Well managed financial
integration, combined with sound regulatory practices, can help the
region maximise its economic growth potential while maintaining
financial stability. I have chosen therefore to focus on these
topics.
2. I will try and lay out a case for closer financial
integration in Asia, both as a means of achieving more efficient
allocation of resources in the region, thereby contributing to
continued economic growth, and as a means of supporting financial
stability. I will also discuss what concrete steps can be taken,
and are being taken, to further financial integration in the
region. Expanded intra-regional flows of funds do potentially
expose financial institutions to new types of risks. Hence I will
argue that regulators need to be vigilant as the integration
process proceeds. Here in Hong Kong, we are actively working to
implement the latest supervisory standards. This should ensure that
our banking system will be ready to take on the new challenges
associated with greater financial linkages in the region.
3. But let me start at the beginning, namely, the definition of
financial integration and what benefits it is likely to bring.
4. The fundamental characteristic of financial integration is
that net savers in an economy can have access to any investment
vehicle regardless of the geographical location of either the saver
or the issuer of the investment product. Similarly, entrepreneurs
seeking funds to finance capital expenditure plans can, in a
financially integrated area, have access to sources of credit
irrespective of geographic location.
5. Put differently, financial integration permits the efficient
transfer of funds between economic units that save in excess of
their investment plans to economic units for which the opposite is
true. As a result, net savers will receive the highest return on
their funds, and the investors will obtain credit on the lowest
available terms. In addition, financial integration enhances
competition in each locality since savers and investors are not
constrained to deal only with local suppliers of financial
services, but can search for the most efficient supplier in the
entire integrated area.
6. It is uncontroversial to suggest that financial integration
within a given jurisdiction will be beneficial for the economy as a
whole. Few would question that financial integration within the
United States, for example, has made a positive contribution to
that country's economy. And, I am sure that the increasingly
comprehensive financial linkages across provinces in Mainland
China, would make the mobilisation of the high savings and the
allocation of capital there more efficient, leading to sustained
economic dynamism. But the benefits of financial integration need
not occur only within a single jurisdiction. Observing from afar
the process of economic integration in Europe, it is clear to me
that financial integration across national borders will make a
positive contribution to the region's economic development. But I
shall leave it to other speakers in our conference, particularly
those with first-hand experience in Europe, to elaborate on that
point.
7. Here in Asia, financial integration across economies has not
proceeded as far as within either North America or Europe, even
though the degree of economic, in particular trade, integration
within the region has been rising sharply. As I have pointed out
elsewhere, in the financial sphere Asian economies are less
integrated with each other than with economies in the rest of the
world. I believe that economic integration, brought about by market
forces, having regard to comparative advantages in production, can
best be served by financial integration of a similar degree.
8. I should emphasize, however, that this is as yet merely a
belief on my part. I have so far found it difficult to provide
empirical evidence to support my hypothesis that the optimal degree
of financial integration is the same as, or close to, the degree of
economic integration within a region. To start with, there are
theoretical difficulties in identifying measures of optimality. In
addition, there is no established measure of the actual degree of
financial integration, let alone the actual degree of economic
integration.
9. Lack of empirical evidence notwithstanding, one intuitively
thinks that the synergy driving economic integration can best be
harnessed financially by the stakeholders themselves, who know
better what they are doing and take a longer term view, rather than
by those, motivated largely by relatively short-term financial
rates of return, and acting in accordance with credit assessments,
conducted many miles away from where the action is.
10. Regrettably, for a variety of reasons, financial integration
in Asia lags considerably behind economic integration. Currently, a
sizable portion of gross savings in Asia finds its way into debt
instruments of governmental and quasi-governmental issuers in
industrialized economies, while investment in Asia is financed, to
a significant degree, by capital from those same countries. This
state of affairs seems incongruous and is a reflection of the
relative lack of integration between the financial markets among
Asian economies. It seems to me quite likely, that the cost of
capital for enterprises in Asia would be lower, if there was a deep
and well-functioning corporate bond market in the region to tap the
considerable pool of savings, much of which now flows instead to
industrial countries.
11. In the other direction, the dependence of regional
investment on funds from external sources is not only incongruous;
it also exposes the region to the 'sudden stop' phenomenon, whereby
the flows of capital dry up abruptly, wreaking havoc with real
economic activity. This well-documented feature of international
capital flows, especially costly to emerging market economies, has
unfortunately lead to greater policy conservatism towards financial
openness, at least in this region, thus limiting and slowing down
the pace of financial integration. But, in my opinion, it is for
precisely this reason that financial integration in Asia should be
pursued more vigorously.
12. One effective defence against volatile global financial
flows is a large and financially integrated regional market.
Speaking from experience, there is, I think, other things being
equal, a non-linear relationship between vulnerability to financial
instability and the size of financial markets. The very small
financial markets are not attractive to international capital
because of the lack of liquidity and so there is little volatility
generated by the inflow and outflow of international capital. At
the other extreme, where financial markets are very large relative
to international capital, sudden movements of the latter will only
lead to ripples, which are not big enough to cause any
financial-stability concerns. The most vulnerable financial
markets, other things being equal, are the medium-sized ones, which
have adequate liquidity to attract international capital but which
are, unfortunately, small enough for short-term trends to be
dictated by large operators looking for short-term gains. There is
also the temptation, for some, to engage in manipulative behaviour,
amplifying volatility and vulnerability to financial
instability.
13. I do not want to give the impression that the size of a
financial market can substitute for sound macroeconomic policies as
a guard against volatile capital flows. Indeed, I take it for
granted that the authorities in the region are committed to prudent
monetary, exchange-rate, and fiscal policies. But I am convinced
that expanding the effective size of Asian financial markets
through greater integration across jurisdictions, can increase the
ability of our economies to absorb the volatility of international
capital, as effectively as the US and European markets. It is
therefore heartening to observe that several official initiatives
towards greater financial linkages in the region are bearing fruit,
notably the Chiang Mai and the Asian Bond Fund initiatives. I note
that my colleague Julia Leung will describe the latter in some
detail in the afternoon session.
14. Having made the economic case for increased financial
integration allow me to spend a few moments outlining some
practical steps that may be taken to achieve it.
First, it is necessary to establish linkages
between jurisdictions across the whole spectrum of financial
infrastructure - the trading, payment, clearing, settlement and
custodian systems for money and for financial instruments. This
would facilitate the movement of savings between jurisdictions and
make cross-border transactions more efficient. In this age these
linkages are neither difficult nor costly to establish as the
technology, in the form of electronic messaging platforms of
acceptable security, is already available and in international
use.
15. The second element concerns the relaxation
of non-supervisory restrictions, where they exist, against access
by foreign financial intermediaries to the domestic financial
markets. The size of financial intermediaries, measured for example
in terms of capital, is often a barrier to market access; but, as
we know, size is not necessarily a good indicator of quality.
Capital adequacy, assessed objectively by reference to risk,
provides a better safeguard. Greater competition, wherever it comes
from, also enhances efficiency, although allowances should be made
for the weaker domestic institutions to enable them to cope and
find viable long-term solutions, in the interest of financial
stability.
16. The third element concerns the
harmonisation of standards in the financial system. A degree of
harmonisation, at least the adoption of minimum acceptable
international standards, is essential for improving investor
confidence and enriching the flow of capital within the region. It
would also be conducive to the stability and integrity of the
financial system. I would emphasise the word "international" as
there is no reason to develop regional standards different from
those that have already been developed by international financial
institutions and professional bodies, together with supervisory
agencies.
17. The fourth element concerns the
strengthening of co-operative efforts in financial system
development. As I have already noted, in Asia we have been making
good progress in our efforts to develop the domestic and regional
debt markets through various regional forums and involving the
international financial institutions. In the context of developing
Asian Bond Fund 2, for example, we have achieved a few firsts,
including the introduction of the first exchange-traded bond index
fund in Asia, arranging for two Asian markets to allow
exchange-traded funds for the first time, and opening up the
renminbi inter-bank bond market for the first time to foreign
investors.
18. The final, and probably most difficult,
step towards creating an integrated Asian financial market involves
the relaxation of statutory restrictions on cross-border capital
flows. It is likely to be the most difficult, in part because it
depends on the ability of the financial system in individual
jurisdictions to cope with the ensuing risks.
19. This last point brings me to the next issue I wish to touch
upon in my remarks, namely, the need for a strong and efficient
regulatory framework that is adapted to the integration of the
domestic financial system with that of other jurisdictions.
20. Greater financial integration across jurisdictions brings
about at least two new sources of risk facing domestic financial
institutions. The first and most obvious is the risk of currency
mismatches when cross-border transactions involve the use of
different currencies, as they are likely to do in Asia for the
foreseeable future. Although monetary integration is a topic that
is often mentioned in the region, its realisation, if indeed it
occurs, is almost certainly going to take considerably more time
than it will take for financial markets to become more closely
linked. In the meantime, financial systems will have to be robust
with respect to fluctuations in exchange rates that may impact
assets and liabilities of financial institutions differentially. Of
course, the financial turbulence in 1997 and 1998 has already
alerted both regulators and the private sector to these risks, but
if financial integration leads to increased cross-border financial
commitments for domestic financial institutions, the size of the
risks may become larger.
21. If integration has the desired effect of increasing
cross-jurisdiction intermediation between savers and investors, or
if it leads to cross-jurisdiction establishment of subsidiaries and
branches, the nature of credit risks facing financial institutions
may also change. Exposures to different business cycles will
increase as will exposures to different sources of idiosyncratic
risk. Supervisory agencies need to make sure that appropriate risk
control measures are implemented in individual institutions, and
that their capital adequately reflects the market, credit and
operational risks they are exposed to as they enter foreign
markets.
22. Here in Hong Kong we are well on our way to implementing the
latest international standards in this respect, i.e. the Basel II
standards. As the bank supervisor, the Hong Kong Monetary Authority
has been working with banks and legislators to ensure that we are
able to implement the new standards by 1 January, 2007. We have
also been working with other regulators in the region through the
EMEAP Working Group on Banking Supervision to share our experiences
on the implementation process.
23. Ladies and Gentlemen, I have given you a brief personal
perspective on financial integration and regulation in our region.
I do not know whether I have convinced you of the importance of
these topics for our continued economic prosperity and financial
stability. But I certainly hope to have persuaded you that they are
topics that deserve our attention whether we are policy makers,
regulators of the financial system, or members of the
private-sector financial community. I am sure that more will be
said about these topics throughout the conference, and I look
forward to hearing from our European colleagues about the
experience in Europe concerning financial integration and
regulation in the Euro area.
