Greater regional co-operation and diversification of financial intermediation channels is in everyone's interest.
There seems to be a consensus that financial integration in Asia lags considerably behind the rapid trade and economic integration in the region observed in the last decade or so. The consensus is that Asia would benefit from greater financial integration, with the financial systems becoming more stable and efficient in performing the important role of financial intermediation, making economic growth and development in Asia more sustainable. Some have gone even further, advocating discussion of monetary integration in Asia as a long-term, strategic goal, but so far there has been no noticeable support or interest at the political level. Co-operative efforts among the central banks in Asia, on a wide spectrum of central banking functions, have, nevertheless, been increasing.
Arising from the consideration of financial and monetary integration is the issue of the diversity of financial intermediation channels in Asia. There seems to be a consensus that the channels are not diversified enough: relying too much on the banking systems while the debt markets are under-developed, with unfavourable implications for the robustness of financial systems leading to concerns about vulnerability of individual jurisdictions in Asia to disruptions in financial intermediation. Central banks have been working together to develop the regional debt market, at the same time benefiting individual, domestic debt markets. The two Asian Bond Funds of the Executives' Meeting of East Asia-Pacific Central Banks are good examples. In my opinion, we would all benefit from further strengthening this kind of effort and developing a more structured co-operative approach.
One cannot underestimate the impact of financial market volatility in formulating any co-operative mechanism. This is especially true for Asia, given the great divergence among the economies in the region. Although the observed volatility of financial markets (particularly equity markets) has been on a general decline in recent years after the Asian financial crisis, the potential for much greater volatility remains and the reduced volatility may erode, if it has not already done so, the vigilance of financial institutions towards risk management. It is not possible to predict what might trigger volatility large enough to expose hidden structural problems. But there is no lack of candidates: the global imbalance, the yen carry trade, the compression of risk premiums, geopolitical tension, terrorism, the sub-prime mortgage market in the US, macro adjustment and control in Mainland China, and so on. While monetary authorities in Asia are glad to note that the financial-stability analyses from investment houses and international financial institutions have so far drawn benign conclusions, including the much-talked-about de-coupling of the US economy from the rest of the world, I continue to sense general nervousness and caution among many of my fellow central bankers in the region. I certainly hope that these worries on the financial front will prove to be unfounded.
To ensure financial stability in the region continues, we must deal with the structural defects in the financial markets. Market concentration remains a concern, so does the opaqueness of large market participants and the hedge funds. There is also a readiness to embrace the latest financial innovations, which does not seem to be matched by efforts to understand and manage the associated risks. I agree entirely that financial innovation can improve financial efficiency and stability. But I must confess to a degree of scepticism about the introduction of, for example, credit default swaps, in jurisdictions where the fundamental task of the financial system to mobilise domestic savings into the hands of those in need of funds is still being done with a low level of efficiency and inadequate diversity.
Joseph Yam
14 June 2007
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