Redefining Strategic Routes to Financial Resilience in ASEAN+3

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• Publisher: Asian Development Bank
• Year: 2021
• Print ISBN: 9789292691875
• eBook ISBN: 9789292691882
• Topic: Business
• Subtopic: Financial Engineering
• Index: Business

Rapid globalization and digitalization have transformed the financial landscape of ASEAN+3—the Association of Southeast Asian Nations (ASEAN) and the People's Republic of China, Japan, and the Republic of Korea. Despite impressive reforms, the region faces continued challenges. These include deepening corporate bond markets, coping with cross-border bank concentration risk, reducing dependence on the United States dollar, achieving sustainable infrastructure investments, addressing pension issues, and supporting fintech development. This edited volume highlights the potential for stronger regional financial cooperation to address such challenges. It explores how regional financial cooperation could promote greater financial resilience and stability amid rapid economic and financial development and technological change.

1 Overview of Financial Development and Cooperation in ASEAN+3

Cyn-Young Park and Ramkishen S. Rajan

1.1 Introduction

Asian financial systems have achieved significant development and integration over the past decades. From mostly state-funded and bank-dominated during the period of industrialization in the 1970s and 1980s, the region’s financial systems have become more diversified and market-based. While most Asian financial systems remain bank-dominated, the scope of financial products and services has broadened and new corporate financing sources are proliferating.

Fundamental changes and reforms are often triggered by large shocks or episodes of financial crisis. The Asian finance sector’s experience is no different. Indeed, it was not until the Asian financial crisis that the region’s economies embarked on major reforms to restructure, strengthen, and diversify their financial systems. For the ASEAN+3 economies—the 10 members of the Association of Southeast Asian Nations (ASEAN), plus its main trading partners, the People’s Republic of China (PRC), Japan, and the Republic of Korea—reforms went hand-in-hand with a conscious effort to promote financial cooperation and hence reduce the risks of repeating a crisis.

Highlights of financial cooperation include the introduction in 2010 of a multilateral currency swap arrangement, the Chiang Mai Initiative Multilateralization (CMIM), and the creation of the ASEAN+3 Macroeconomic Research Office (AMRO) which was accorded legal status as an international organization in 2016. These have given a fillip to financial cooperation among ASEAN+3 economies. Rather than retreat from global financial markets, the economies recognized the need to become more connected with them, while trying to do so in a manner that minimizes disruption. The region’s financial systems held up relatively well during the United States (US) taper tantrum in 2013, and again in the turmoil of March 2020 at the height of panic over the coronavirus disease (COVID-19) pandemic, thanks in part to the post-Asian financial crisis reforms and policy lessons that led to improved macrofinancial surveillance, strengthened financial regulations, and enhanced regional financial safety net arrangements and institutions.

This volume explores the present state of affairs of financial cooperation and development in the region since the global financial crisis. It takes the story forward from the first volume, which offered useful historical context to financial development since the Asian financial crisis struck in 1997.¹ Much has been achieved in the past 25 years, yet a great deal still needs to be done to make the region’s finance sectors more inclusive and safer for society. This includes developing market structure to expand and build a more liquid financial system and finding innovative ways to finance the real sectors and reach people excluded from the formal financial system. It also means continuous strengthening of financial resilience and safeguarding stability amid the rapid economic and financial development driven by advances in technology.

This first chapter sets the scene for how regional efforts can continue to improve financial systems in Asia. It starts by offering some theory about and evidence of financial integration and its opportunities and challenges, and goes on to review the evolution of ASEAN+3 financial systems with a focus on the growing internationalization of the ASEAN+3 banking system and the development of local currency bond markets over the past 2 decades. A comprehensive picture of challenges ahead cannot ignore the shock of COVID-19 on regional financial systems, nor the looming risks to debt sustainability and the revolutionary impact of digital transformation on financial services. To gauge the region’s resilience to financial contagion, the chapter examines sides to the debate around the capacity of flexible exchange rates to insulate from global shocks, especially in the context of growing US dollar borrowing and its dominance in pricing for international trade. It also touches upon the role of international reserves as a self-help mechanism and revisits actions being taken to improve regional monetary cooperation. While aiming to put issues facing ASEAN+3 policy makers into sharp focus, the chapter concludes with suggestions of steps that can be taken as a region to build more resilient financial systems.

1.2 Financial Openness and Growth: Theory and Evidence

Financial openness and integration is a complex concept with many dimensions, including de jure capital account openness, how financial institutions can better operate across jurisdictions, and the extent to capital can flow across borders (i.e., de facto openness). Several studies, beginning with the influential works of McKinnon (1973) and Shaw (1973), have argued that a movement away from “financially repressive” policies can bring growth benefits by eliminating credit controls, deregulating interest rates, and allowing banks to compete with each other. While the initial McKinnon-Shaw analysis focused on domestic financial liberalization, a burgeoning literature has since extended the discussion to external aspects. The general conclusion is that financial development combined with proper sequencing of liberalization could spur economic growth through efficient allocation of capital across borders and transfer of best practices in technological know-how and management, complemented by increased production specialization and better risk management (Bekaert, Harvey, and Lundblad 2005, Williamson and Mahar 1998).²

However, a large body of literature building on Stiglitz (2004) has cautioned that information asymmetries stemming from a lack of transparency in financial institutions could lead to inefficient allocation of capital, generating maturity mismatches that contribute to costly financial crises (Stiglitz and Weiss 1981). The empirical literature does not establish conclusively that financial openness has had any discernible positive impact on growth (Eichengreen 2001, Contessi and Weinberger 2009, Kose et al. 2009). While the growth effects of financial openness are contested, it can be said with certainty that where liberalization fails to take place in a well-sequenced and timed manner—such as development of the domestic financial market and regulatory system before financial openness, and openness to long-term capital before short-term capital—episodes of severe financial instability and distress may result (Bird and Rajan 2001, Cobham 2002, Prasad and Rajan 2008).³ Similarly, Kose, Prasad, and Taylor (2011) find the indirect benefits of international financial integration on growth, such as developing domestic financial markets and improving corporate and public governance, may be more important than direct benefits. They also note that for countries to reap some of these benefits, they require a certain “threshold” of domestic financial and institutional development, without which financial liberalization may be accompanied by unintended risks, including financial crises.⁴

In summary, financial integration offers potential benefits but also poses risks and costs. Past literature points to a broad set of indirect “collateral benefits” of financial openness. However, in some cases the benefits, such as of local financial sector development, institutional development, better governance, and macroeconomic discipline, may be enjoyed only if “threshold conditions” related to financial market development, institutional quality, governance, macroeconomic policies, and the like are met. This suggests that there may be bidirectional causality. For instance, although enhanced financial openness encourages efficient financial markets, whenever existing financial markets are underdeveloped, the gains from openness may be limited and it may fail to attract capital or the “right” form of capital. Countries below the threshold may fall into a ‘financial globalization trap’ (Prasad et al. 2003), something that the low- and middle-income members of ASEAN+3 have to pay attention to.⁵

Experiences with the Asian financial crisis and subsequent crises have underscored the importance of sequencing market-oriented reforms with financial liberalization (McKinnon 1991), focusing on improvements in regulation and supervision, transparency, and contract enforcement (Beck, Demirgüç-Kunt, and Levine 2003; La Porta et al. 1997). The global financial crisis further highlighted the risk from deeply entwined financial networks that allow fast and wide transmission of shocks across markets and borders. It also cast doubt on the ability of financial regulators to properly monitor overly complex financial products and transactions amid rapid globalization or innovation.

Viewing financial globalization through the narrow prism of global capital flows, cross-border capital surged remarkably in the years prior to the global financial crisis, with overall gross capital inflows peaking at $12.0 trillion in 2007, or about 19% of global gross domestic product (GDP). Following a sharp decline in gross capital inflows to ASEAN+3 in 2008 and 2009, the region attracted significant capital in bouts between 2010 and 2013, with gross capital inflows touching $1.0 trillion in 2013, surpassing levels in 2007 (IMF, Balance of Payments Statistics). Such record capital inflows consisted mostly of relatively short-term bank-related and other private flows (Balakrishnan et al. 2012).

Another important dimension of financial integration is foreign bank presence and cross-border banking activities. Foreign banks could contribute to overall financial sector development by helping reduce cost structures; improving operational efficiency; and by introducing new technologies and banking products, marketing skills and management, and corporate governance structures. They could also make financial services more accessible for households and firms.⁶ Based on available data for ASEAN+3, as Figure 1.1 captures, the average share of foreign banking institutions in the total number of banks has steadily risen from 2010 to 2013, but has declined since to about 42% in 2020. In comparison, the average share of banking assets owned by foreign banks appears to have not changed much in the last 10 years.⁷ The foreign bank participation rate in the ASEAN+3 economies is also lower than other regions such as sub-Saharan Africa and Latin America and the Caribbean (Figure 1.2).

Figure 1.1: Foreign Bank Presence in ASEAN+3

Note: The data pertain to simple averages of economy-level ratios covering economies with data. The definitions and coverage may vary across economies. The economy composition of each variable also differs. For assets, all ASEAN+3 e...

Table of contents

• Front Cover
• Title Page
• Copyright Page
• Contents
• Tables, Figures, and Boxes
• Foreword
• Preface
• Acknowledgments
• Editors
• Authors
• 1. Overview of Financial Development and Cooperation in ASEAN+3
• 2. Sailing the Same Stormy Seas: Slow-Burn Contagion Risk in ASEAN+3
• 3. The Global Monetary System and Use of Regional Currencies in ASEAN+3
• 4. Fintech in ASEAN+3 and Implications for Financial Inclusion and Financial Stability
• 5. Financing Sustainable Infrastructure Investment in ASEAN+3
• 6. Pension Challenges in Aging Asia
• 7. Regional Financial Cooperation in ASEAN+3: Taking Stock and Moving Forward
• Index
• Back Cover