Asian Perspectives on Financial Sector Reforms and Regulation

Introduction

ix Introduction eswar s. prasad The global financial crisis that ravaged financial systems in the advanced economies and many emerging markets as well has necessitated the reconsideration of even the basic principles of financial regulation. Remarkably, emerging market financial systems in Asia have in general proved to be more robust and less affected by the global turmoil than their advanced economy counterparts. In light of that, it is important to carefully filter out the right lessons from this outcome . Moreover, the imperative of financial development remains as strong as ever in Asian emerging markets, although the focus is more on basic elements, such as strengthening the banking systems and widening the scope of the formal financial system, rather than on sophisticated instruments and innovations. The crisis highlights the need for strengthening financial systems to make them more resilient to shocks. Asian emerging markets face particular challenges in stabilizing their nascent financial systems in the face of shocks, both domestic and external, and financial reforms are critical to these economies as they pursue sustainable high-growth paths. Policymakers in Asian emerging markets are grappling with a distinct set of issues, including the lessons the crisis can offer for the establishment of efficient and flexible regulatory structures, the avenues that should be pursued to enable This book adopts the Asian Development Bank naming convention of referring to its member economies. The Brookings Institution takes no position on the legal status of Taipei,China. 12689-01_Intro-rev.qxd 10/5/11 12:18 PM Page ix x eswar s. prasad effective regulation of financial institutions with large operations in multiple countries, and the ways to achieve greater financial inclusion. A broad reconsideration of the optimal structure and appropriate regulatory and supervisory frameworks of financial institutions is needed for these economies. The chapters in this volume provide different perspectives on designing effective strategies for maintaining the momentum of financial development and inclusion in Asian emerging markets, while strengthening macroeconomic and regulatory frameworks to promote financial stability. Macroeconomic Frameworks for Financial Stability Because of the financial crisis, attention has been drawn to the intricate interplay between macroeconomic and financial policies, both national and global. The absence of stable macroeconomic policies can hinder financial development. In addition, weakly supervised and inefficient financial systems can hamper the effectiveness of policy transmission mechanisms and make it harder to manage stable policies. Capital accounts that are becoming more open in both de jure and de facto terms add a further layer of complications in determining the right structure of macroeconomic frameworks. In the aftermath of the financial crisis, policymakers in emerging markets are again being confronted by conditions that are creating risks to monetary and financial stability. In chapter 1, “Monetary Policy Challenges for Emerging Markets in a Globalized Environment,” Sukudhew Singh explores three of these policy issues. One of them is easy monetary policies in the advanced economies, specifically unconventional monetary policies. The chapter argues that these policies are fostering volatility and distortions in the financial markets and creating risks for emerging markets. The second policy issue is management of asset price bubbles. Asian central banks will have to adopt a proactive approach and overcome the current intellectual paralysis regarding the role of central banks in managing asset price bubbles. The third policy issue is that, in a period of low global interest rates and ample liquidity, commodity prices are again on the rise, which could have dire consequences for emerging markets. Central bank vigilance to guard against spillovers into broader inflationary consequences is essential. In mid-September 2008, following the bankruptcy of Lehman, international interbank markets froze, and interbank lending beyond very short maturities virtually evaporated. Despite massive central bank support and purchases of key assets, many financial markets remained impaired. Why was this funding crisis so much worse than other past major bank failures, and why has it proved so hard to cure? In chapter 2, “The Great Liquidity Freeze: What Does It Mean for International Banking?” Dietrich Domanski and Philip Turner suggest that much of the answer lies in the balance sheet between banks and their customers. It outlines the basic building blocks of liquidity management for a bank that operates in many 12689-01_Intro-rev.qxd 10/5/11 12:18 PM Page x introduction xi currencies; it then discusses how the massive development of the foreign exchange market (forex) and interest rate derivatives markets transformed banks’ strategies in this area. It...