Credit enhancement

inSight

15 Aug 2002

Credit enhancement

Proposals under development by the HKMA for the use of securitisation and credit guarantees could help promote financial stability by giving a much-needed boost to the Asian debt market.

I said last week that I did not see the possibility in the foreseeable future of a major breakthrough in the pursuit of global or regional arrangements for the effective management of the risks faced by small open markets. I should probably have distinguished between global arrangements and regional arrangements, in that, if there is to be a major breakthrough, the probability of the latter's occurring is significantly higher than that for the former. Indeed, there has been a lot of effort, not least from the HKMA, to promote Asian monetary co-operation.

There have also been results, although I would not say that any of them represents a major breakthrough. From a willingness to provide each other with liquidity, in the form of the bilateral repos of US Treasuries we initiated in 1995, many jurisdictions are now engaged in discussions on the provision of credit as well, whether or not conditional upon the undertaking of prescribed reform measures. These are, no doubt, encouraging developments, but they focus predominantly on the provision of assistance in crisis resolution when, to ensure lasting financial stability, there should be much greater emphasis on crisis prevention arrangements.

My first serious attempt in raising the subject of Asian monetary co-operation was when I was given the honour of delivering the Per Jacobsson Lecture of 1997 on the occasion of the World Bank and IMF annual meetings held here in Hong Kong. In that lecture I queried the effectiveness with which financial intermediation in the region had been taking place. The majority of official sector and institutionalised private sector savings of the region had to be channelled into investments in the region through the developed markets. This might be a manifestation of increasing globalisation, but, in taking this rather more circuitous route of international financial intermediation, Asia also imports financial volatility and this had been proven to be difficult to handle.

The effectiveness of financial intermediation in the region - a very rich region in terms of savings - can be enhanced through the creation of efficient and safe channels within the region. This means, among other things, the development of an active debt market, alongside the rather more established banking and equity markets, and encouraging greater financial flows through that channel. Diversity in financial intermediation enhances financial stability. But the creditworthiness of many potential debt issuers in Asia, given a host of factors, is generally lower than desired by institutional investors, particularly those managing official foreign reserves.

As part of our effort in promoting debt market development, we have recently put forward proposals in international forums on arrangements that will have a credit enhancement effect, in order to increase the supply of debt in the region to the more conservative investors. Without going into the technical details, these arrangements involve the use of securitisation and credit guarantees. These ideas are not new and there are successful examples of such arrangements in other regions. Here in Hong Kong much of the activity of the Hong Kong Mortgage Corporation is built upon these ideas. But typically there is a need in these arrangements for assistance from a third party of high credit standing to achieve the credit enhancement. On a regional level, this role should suitably be played by the international financial or developmental institutions who, in any case, have a keen interest in promoting financial sector development in the region - very much a pre-requisite for sustainable economic growth and development.

Apart from creditworthiness, the small size of issuers and therefore the size and liquidity of the debt issued by them have also inhibited the effectiveness of the debt channel in financial intermediation. Unlike those in the large developed economies, financial markets in non-Japan Asia are rather fragmented, in terms of both size and currency denomination. It should be interesting to readers to note, for example, that the market capitalisation of a large listed company in the US is easily equivalent to the combined GDP of two or even three economies in non-Japan Asia. So, even if there are issuers of acceptable credit standing, they are too small to be of interest to the large institutional investors in the region. The proposals we are pursuing can also be used to pool the small issuers or issues together by securitising a pool of their debt or, indeed, their other revenue-producing assets.

 

Joseph Yam

15 August 2002

 

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