3. Issues for the Future: Construction of Efficient and StableFinancial Systems in Asian Countries
To build efficient and stable financial systems in Asian countries,it is important to allocate economically rational roles that make the most of the strong points ofboth local and foreign banks, private banks and the government, and the banking sector and thesecurities sector, as well as to further promote the disposal of non-performing loans and otherongoing efforts.
(1) Foreign Banks and Local Banks
(Effects of Participation by Foreign Banks)
| -1- | Participation by foreign banks is important not only as a source of funds, but also for reforming aspects of corporate behavior, such as management know-how, technology, and governance. Local banks that were bought by foreign banks have promoted disposition of non-performing loans and switched to profit-oriented management systems by installing new managers. We also think that local banks may be expected to have a strong incentive to switch to profit- and efficiency-oriented management through competition with foreign banks that have started operating locally to acquire blue-chip companies as customers. |
(Vitalization of Local Banks)
| -2- | However, as stated earlier, in the current situation, the local banks' territory has shrunk since Western banks have moved into local markets in earnest. It has been pointed out that local banks have selected small-lot loans and consumer financing, while their financing of businesses has declined relatively. Considering the need to efficiently allocate domestic savings and steadily expand domestic demand to maintain stable growth, it is important that local banks stimulate the financing of domestic businesses (in the case of Asia, this means small and medium-sized businesses in particular). Toward this end, it is necessary to promote further environmental changes that will allow banks to operate independently and efficiently, while further promoting corporate restructuring, including the resolution of corporate debt. | |||||||||||||||||||
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(2) Strengthening of Bank Monitoring Functions
(Improvement in Effectiveness of Prudential Regulations)
| -1- | To promote environmental changes that will allow independent and efficient operation for the vitalization of local banks, it is essential to improve the effectiveness of prudential regulations that secure healthy management, by strengthening bank monitoring functions (including loan examinations). |
(Separation of Banks from Development Policies and the Issue ofCorporate Groups)
| -2- | Asian banks have often explicitly or tacitly been demanded loans and received loan guarantees from the government, and they were sometimes incorporated into corporate groups as "institutionalized banks". Therefore they have always had extremely little incentive to monitor corporations. This situation prevented the development of risk-management and assessment, and internal control systems remained undeveloped. To strengthen the monitoring functions of banks, it is important to: | |||||||
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(Problems with Corporate Groups)
| -3- | In connection with the issue of corporate monitoring by banks, it has long been pointed out that extremely arbitrary management is conducted mainly by large shareholders among the kind of family businesses that are characteristic of some Asian companies. They have accumulated huge debts from non-transparent loans, including bank lending which made use of political power and led to the currency and financial crises. Not all family businesses perform particularly poorly compared to other businesses, such as those whose shares are more widely distributed. Thus, it is not the simple case that all family businesses are bad, but it could be suggested that we should focus on corporate entities with a group organization. In other words, in corporate groups, the following problems exist, which may well have provided a basis for the currency and financial crises: | ||||||||||
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(Improvement of Regulatory Authorities' and Banks' Human Resources)
| -4- | Prudential regulations and bank auditing systems have been strengthened in Asia since the crises, but capable people are not being trained fast enough to meet demand. Improving the quality of regulatory authorities' bank supervision and banks' internal examination will probably take additional time. (Toward this end, technical assistance is being provided through international institutions, such as the IMF, World Bank, and ADB, and bilateral.) |
(3) Expansion of Financing for Small and Medium-sized Businesses
Whereas major corporations and export-oriented manufacturingcompanies can procure funds relatively easily through new bank lending or corporate bond issuance,small and medium-sized businesses and domestic consumption-oriented manufacturing companies oftenhave trouble procuring funds. The government's giving guidance to private banks and demanding themto increase lending against their will would undermine the management of banks that have begun tomake their lending decisions based on the level of credit risk. Currently, there may be a need touse government policy to establish adequate facilities for small and medium-sized businessfinancing, while at the same time to increase banks' efficiency by consolidating inefficient banksthrough ongoing realignment in the banking sector and to create banks that meet internationalstandards.
(4) Provision of Long-term Credit
Financial systems in Asian countries have always been poor atproviding long-term credit, and this has been cited as a factor behind the currency and financialcrises. Development of domestic bond markets is one possible route for long-term corporate fundprocurement, but, as will be explained below, that will take some time to materialize. Therefore wesuggest that it may be necessary to consider some measures aimed at boosting the capacity forlong-term financing in each Asian country while developing domestic bond markets. Examples of suchmeasures would be creating specialized financial institutions and introducing long-term funds fromoverseas.
| -- | One of the reasons that the long-term credit-providing function is weak in Asian financial systems may be that at the end of the 1980s, when Asian countries shifted to financial liberalization policies, they changed their ideas about development. Specifically, until then Asian countries pursued industrialization primarily through domestic companies supported by their financial system. This way of thinking shifted toward pursuing industrialization by actively placing foreign companies at the center of upgrading the industrial structure. With foreign companies at the center of industrialization, the need to internally generate long-term funds for industrialization may have declined. |
(5) Development of Capital Markets
(Complementing Bank Lending)
| -1- | The banking sector is likely to continue to play the central role in Asian financial systems, but, based on the lessons of previous currency and financial crises, it is important to develop local stock and bond markets - which can still not be said to be functioning efficiently - to complement bank lending in order to make good use of the abundant domestic savings, especially from the standpoint of long-term credit provision, and to encourage investment from overseas. | |||||||
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(Improving Market Environments)
| -2- | For the development of capital markets, such as stock and bond markets, it is essential to create an environment in which fund-providing capitalists as fund providers - i.e. local institutional investors, individual investors and foreign investors - can easily participate. It is also necessary to increase the number and variety of corporations, that are issuers and fund borrowers, and to secure their soundness and transparency. Toward this end, it may be necessary to strive to promote adequate functioning of market principles by strengthening corporate governance, improving transparency through corporate disclosure, and establishing accounting systems that meet international standards, etc., in addition to offering a diversity of financial instruments. |
(Role of Foreign Investors)
| -3- | At present, in Asia it would be difficult to have domestic institutional investors fulfill the function of institutional investors that is indispensable to the development of capital markets while many Asian countries still have immature pension funds and insurance companies. Therefore, it is important to have foreign investors serve as long-term investors. (A member of the Expert Group stated that in Asia foreign investors as shareholders have had a positive influence on corporate governance and performance, and listings on overseas markets and bond ratings are contributing to the improvement of infrastructure in Asian capital markets.) | |||||||||||||||||||
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(Improvement of Government Bond Markets)
| -4- | Because Asian governments have purchased non-performing loans from banks and injected public funds in banks to boost their capital mainly by exchanging or injecting government bonds and government agency bonds, we see development and maintenance of secondary markets for government bonds as an urgent matter. (If government bond markets are improved, yields on low-risk, sovereign bonds can be expected to serve as benchmarks for bond markets.) |
(1) Financial Institutions
| -1- | In Asian countries, where banks do not adequately function as financial intermediaries, not only do foreign banks provide funding, but as has been mentioned earlier, they are expected to provide management know-how and technology, and to reform governance and other aspects of corporate behavior. In the case of Japanese banks, currency and financial crises in Asia coincided with the financial crisis in Japan. Since the crises, lending to other Asian countries has declined sharply. For Japanese banks, there is high profit potential in Asian credit, and Asia retains its important position in their international financial business strategies. But from the standpoint of risk management and making good use of limited resources, the strategy of Japanese banks for making the most of their own strengths is different from that of Western-affiliated banks. Japanese banks are said to be likely to continue to focus on corporate credit, with a preponderance of weight on Japanese-affiliated businesses as they expand their operations in Asia, rather than focusing on retail. Another opinion was that in order to increase their profile within Asian financial systems and to increase their profit potential, Japanese banks should actively enter retail, local markets, and other fields where growth is expected - as Western-affiliated banks are doing - thereby preparing a solid foothold for themselves. | |
-2- | Amid expectations that merchant banking operations will become more and more important with the development of Asian capital markets in the future, the infrastructure for merchant banking operations, i.e., auditing, consulting, mass media, and rating companies, is being led by the U.S., and Japan needs a strategy for building competitive infrastructure. | |
-3- | Japanese-affiliated firms form a large proportion of Japanese banks' customers in Asia, and their future trends and strategies in Asia have a major impact on the strategies of Japanese banks. With factors such as recent developments in the IT revolution causing major changes in the industrial concentration structure of Japanese-affiliated companies in Asia, many are pursuing a strategy of "strengthening core competencies by selecting and concentrating." In other words, instead of making small profits in a wide variety of fields, they aim to reap big profits by concentrating resources in a very narrow field where they can gain a competitive edge by making use of their unique strengths. Specifically, because of rapid development of China as a marketplace and the establishment of its position as a manufacturing base, this strategy has inspired a movement toward China not only in IT-related industries but in many other industries. Because Asia is a region with an underdeveloped social and economic infrastructure, and political and systemic risks, it may be necessary to consider "risk diversification" along with "selecting and concentrating." Also, along with concentrating resources in a narrow field where one's unique strengths can be exploited, it may be possible to think of developing Asia as a whole (including South Korea, Taiwan, and ASEAN countries as well as China) through mutual cooperation with Asian countries in other fields at the same time. |
Chart: Balance of Credit Provided to Asia byJapanese and Western Banks
 Note: BIS, Europe 5 refers to Germany, France, Italy, UK, and the Netherlands. | |
| Source: | Extracted from documents submitted by Mr. Yamagami at the 8th meeting of the Expert Group. |
(2) Institutional Investors
We believe that having pension funds, investment trusts, lifeinsurers, and other institutional investors improve their functioning as long-term investors andtheir ability to participate as shareholders in corporate management is not just a domestic issuefor Japan, but might at the same time contribute to the construction of efficient financial systems,and especially to the development of capital markets, throughout Asia. We also think it may benecessary to make Japanese stock markets more open to other Asian countries.
| 1) | Since the currency and financial crises, the value of new equity issues in Asia has been growing rapidly, far exceeding pre-crisis levels, because of a string of large-scale stock issues related to privatization in China. The overall balance of Japanese investment in overseas shares (about 30 trillion yen in 2000) has also increased, but the proportion represented by Asian shares is extremely small. Reasons for this situation are believed to include, in addition to the fact that in the past few years the performance of U.S. stocks has been far better than that of Asian stocks, the fact that the only non-Japanese Asian shares included in benchmarks used by most other Japanese institutional investors including public pension funds are Hong Kong and Singapore stocks. |
Table: Balance of Japanese Investment inOverseas Stocks
| (in ¥ trillions) |
| 1996 | 1997 | 1998 | 1999 | 2000 | ||
| All Countries | 18.0 | 20.6 | 24.2 | 29.2 | 30.1 | |
| Asia | 2.5 | 1.1 | 0.8 | 1.3 | 1.0 | |
| Percentage in Asia | 14.1% | 5.4% | 3.1% | 4.6% | 3.2% | |
| Source: | Extracted from data on "Stock Investment in Asia," submitted by Mr. Takeuchi at the 9th meeting of the Expert Group |
2) | Issuance of foreign currency-denominated (including yen-denominated) bonds by Asian entities remains significantly lower than pre-crises levels. Also, only a tiny portion (about 2% as of the end of 2000) of the balance of Japanese investments in overseas bonds (JPY 105 trillion as of the end of 2000) is invested in Asian bonds. However, because Japanese interest rates are low right now, it is much more advantageous for Asian entities to issue samurai bonds compared with dollar-denominated bonds. At the same time, demand for Asian bonds has increased quite a bit among Japanese investors, so we assume that the amount of samurai bonds issued by Asian entities will increase in the future. |
(3) Role of the Government
The Japanese government can be expected to continue to give financialand technical support to structural reform in Asian economies, and to continue to take such measuresas guaranteeing Asian bonds until the private sector recovers its proper role in the financialsystems of Asian markets.
In addition, Japan can probably contribute to the construction ofAsian financial systems by passing on its experience, etc., in such fields as the development of thehuman resources needed for establishing systems for supervising banks, financing for small andmedium-sized businesses, and long-term credit.
5. Summary and Other Points to Consider
(1) Summary
The following is a summary of the main discussion points outlinedabove.
To construct efficient and stable financial systems in Asiancountries in the future, it is advisable to consider the following, in addition to the disposal ofnon-performing loans and other measures that have already been taken:
| -1- | For Asian countries: | |||||
| 1) | To vitalize local banks | |||||
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| 2) | Expand financing for small and medium-sized businesses, and promote policies aimed at providing long-term credit. | |||||
| 3) | To develop stock and bond markets as complements to bank lending, attach importance to the role of foreign investors as long-term investors, while strengthening corporate governance, promoting disclosure, and establishing accounting systems, etc. | |||||
-2- | Additional tasks for Japan: Along with continuing to support structural reform in Asian economies, the Japanese government needs to pass on the experience of Japan in such fields as the development of human resources to establish systems for supervising banks, financing for small and medium-sized businesses, and long-term credit, toward the goal of helping to build financial systems in Asian countries. | |||||
(2) Other Points to Consider
The following items were mentioned as additional points to considerin the future to build efficient and stable financial systems in Asian countries.
| -- | Provision of long-term funds | |
-- | Financing for small and medium-sized businesses Financing for small and medium-sized businesses, including the informal sector, is important. If it is known exactly what kind of programs are being conducted by the World Bank, Asia Development Bank, and private Western consultants in relation to the modernization of bank management, they could be compared to the experience of Japan with small and medium-sized business financing, and it could be suggested exactly what is lacking in Asian financial systems. | |
-- | Improvement of capital markets Improvement of capital markets is important; however, it is necessary to actively cultivate merchant banking operations at the same time as part of that improvement. | |
-- | Efficient use of savings within the Asian region (Investment) How can Japan be involved in linking the abundant domestic savings in Asia with investment opportunities? |
| < | Current Status and Discussion Points Concerning Foreign Exchange Regimes, and Management and Control of Currency Trading and Capital Flows in Asian Countries> |
1. Exchange Rate Regimes
| (1) | Current Status After the Asian currency crises, South Korea, Thailand, and Indonesia switched to a floating system from effectively U.S. dollar-pegged systems. This became a factor behind the crises. Malaysia, however, adopted a fixed-exchange rate regime pegged to the U.S. dollar. China uses a fixed-market system pegged to the U.S. dollar, while Hong Kong has a currency board pegged to the U.S. dollar, and Singapore has an exchange rate regime based on a currency basket weighted according to trade volumes. | ||||||||||||||||||||||
(2) | Discussion Points | ||||||||||||||||||||||
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2. Management and Control of Currency Trading and Capital Flows
| (1) | Current Status South Korea, Thailand, and Indonesia have basically liberalized capital transactions, but recently Thailand and Indonesia are moving toward strengthening limitations on currency transactions that are not based on actual trades, in order to prevent currency speculation. Meanwhile, Malaysia has tried to soften the damage from the currency crisis by adopting the fixed exchange rate regime mentioned above while regulating currency and capital transactions, including a ban on overseas remittances of stock sales for one year and limitations on currency trading. But after six months of the enforcement of these regulations, the ban on remittances was superseded with a tax on remittances. After that, regulations were gradually eased and abandoned in 2001. (However, even now non-residents are completely prohibited from holding ringgit accounts, and overall regulations remain strict.) On the other hand, China suffered relatively little damage from the currency crisis, partly because it had not liberalized capital transactions. But as China will join the WTO and has promoted financial liberalization, it has become more and more difficult for the country to maintain capital controls. | ||||||||||
(2) | Discussion Points | ||||||||||
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