PricewaterhouseCoopers Research Institute (Japan) Co., Ltd. (established in October 2009) hosted a symposium titled "Financial Services in the Era of Asia – The Role of Finance in Supporting Sustainable Growth of the Asian Economy" at the Japanese Bankers Association Ginko Kaikan on January 28, 2010. The symposium was co-hosted by the Japan Center for International Finance, sponsored by the Japanese Bankers Association and Kinzai Institute for Financial Affairs, Inc. and was attended by over 170 people engaged in the financial services sector.
The Asian economy has been attracting greater attention as the "driving force" of the worldwide economy which has been suffering from the recent financial and economic crises. In such circumstances, the question is how Japanese financial institutions, which are experienced as they are based in a developed country which has an established financial system and have know-hows under different business practices in European and American countries, can contribute to the economy of Asia where countries are at various phases of economic development, have different supervisory frameworks for financial institutions and take individual approaches for risk management; and eventually to the global economy. The objective of this symposium was to share views on such a topic with the leaders in the banking and other financial industries in Japan and develop thought leadership on this topic which can help inform the global debate.
For the keynote speech of the event, Mr. Hirofumi Gomi (The former commissioner of the Japanese Financial Services Agency and current chairman of PricewaterhouseCoopers Research Institute (Japan) Co., Ltd.) and Mr. Hiroshi Watanabe (The deputy governor and representative director of Japan Finance Corporation and president & CEO of Japan Bank for international Cooperation) gave an overview regarding lessons learned from and an outlook of the recent financial and economic crises, and regarding future economic developments in Asia and the expected roles of finance, respectively.
Mr. Hirofumi Gomi
There are two factors that triggered the recent financial and economic crises: "incomplete regulations" and "a lack of self-discipline."
One of the reasons the subprime mortgage crisis has resulted in a global financial crisis is that securitization processes lacked transparency, making it difficult to identify and measure risks. Under CDS (Credit Default Swap) contracts, their insurance function did not work as expected because the scheme was not designed sufficiently enough to protect buyers of CDS when a risk arose. In addition, some investment banks, taking advantage of the fact that they were not subject to the Basel Accords, had shifted to high-leverage management in expectation of maximizing short-term profits; which complicated the problem.
Regulatory authorities were not fully aware that "uncontrolled businesses" had been expanding under incomplete financial regulations and thus failed to address the problem appropriately.
To prevent this problem from happening again, stricter regulations will be required to control global and large financial institutions, regardless of whether they are a bank or non-bank.
Nonetheless, in my opinion, recent arguments for tighter regulations are slightly unreasonable because they imply that "a big risk should not be taken." Regulations produce side effects that hamper free innovation. Moreover, one of the original roles of financial institutions is to take risks.
Even if financial institutions take risks, financial stableness will not be affected as long as the regulatory authorities are capable of identifying, managing and addressing risks. Therefore, we should not sacrifice market efficiency for the convenience of the government.
It is difficult to simultaneously achieve freedom and trust in the market only by establishing regulations and therefore, it is important for market participants to demonstrate self-discipline and self-responsibility – to be prepared to sacrifice profits when necessary in managing risks. This combined with establishing regulations under which adequate risk management can be prompted through market discipline with enhanced disclosure requirements will better prevent similar problems.
Mr. Hiroshi Watanabe
In the wake of the recent financial crisis, the GDP of developed countries showed a significant negative growth in 2009. Emerging countries, on the other hand, had momentum to offset such a crisis. Particularly in the high-population countries such as China, India, Brazil and Indonesia, personal consumption expenditures remained robust, supporting the global economy. While the economy of the developed countries has been recovering since the second half of the previous year, unemployment rates of developed countries as well as developing countries are struggling to improve.
The recent financial crisis hindered fund inflows into markets. To solve this problem, central banks significantly increased the money supply, setting extremely low interest rates. Such a stimulus measure has boosted demand including investments in plant and equipment and at the same time lowered fund-raising costs, triggering a shift from labor-intensive businesses to capital intensive businesses. As a result, these days the improvement in productivity is not necessarily attributed to an improvement in employment. Recovering the economy without strengthening employment will eventually lead to a huge political issue for any country.
In the meantime, the Asian financial sector has suffered only slightly from the recent financial crisis because financial institutions have continued to run their businesses cautiously and have been limiting investments into tempting financial instruments based on the lessons learned from the past events including the Asian crisis. Nevertheless, Asia's GDP dropped by 2 to 3% due to a decline in foreign currency inflows which was attributable to the recent financial crisis.
Such a decline in foreign currency inflows was caused by the fact that many financial institutions in European and American countries received public funding and thereby were necessitated to focus their attention on the domestic market, taking priority over the international capital markets.
With large reserves of foreign currency and savings, Japan and China are capable of providing funds to Asian countries or companies in Asian countries by means of swaps or through capital markets. To create a market where this can be realized, both the public and private sectors need to collaborate.
In respect of exchange rates, Asia will need to take paradoxical approaches: (a) to maintain stability while (b) achieving "flexibility," as in enabling current account adjustments by taking advantage of changes in exchange rates.
As for investments, developing new infrastructure as well as maintaining/repairing existing infrastructure will be required. Moreover, it will be necessary not only to invest in projects involving a single country but also to make investments targeting the entire Asian region. What is important is to aim for a growth of Asia as a whole by successfully connecting various countries among which significant disparities in reserves, income and other aspects exist.
Mr. David Eldon
The latter part of the symposium was composed of a panel discussion with Mr. Akira Ariyoshi (Director of IMF Regional Office for Asia and the Pacific), Mr. Luo Ping (Director general, Training Department, of China Banking Regulatory Commission), Mr. Kazuto Uchida (General manager of Economic Research Office, the Bank of Mitsubishi-Tokyo UFJ, Ltd.) and Mr. Tsuyoshi Oyama (Director of Aarata) as a panelist and Mr. David Eldon (Senior Advisor of PwC) as a facilitator. Topics of the panel discussion included the impact of the recent financial crisis on the Asian economy and visions of financial institutions in Japan and other Asian countries.
Mr. Akira Ariyoshi
Mr. Ariyoshi: It is mostly because they have learned lessons from their past experience during the Asian crisis a decade ago. They have succeeded in creating a solid foundation that can weather crises by accumulating foreign exchange reserves, establishing a risk management/supervisory framework and strengthening their capital adequacy.
However, a recovery of the Asian economies following a severe decline is not always a real recovery, as it could be merely a rebound to original levels. Recoveries from financial crises will continue to give rise to economic trends of capital inflows, exchange rates, soaring asset value in a domestic market and impact from the so-called 'exit strategies'
Mr.Luo Ping: The impact on the financial sector was minor in part because bank businesses were not sophisticated enough to deal with securitized products. However, the primary reason was that proper regulations were developed and a thorough measure was taken to ensure compliance with such regulations.
Meanwhile, the real economy suffered severe damage. With export struggling due to shrinking foreign demand, the GDP growth rate plummeted to 6.5% in China. This was critical given that a 1% GDP growth creates job opportunities for 1 million people, a 5-to-6% annual growth is essential to cover 5 million new graduates in China.
GDP growth in the fourth quarter of the previous year showed an increase by 8.7% year-on-year mainly due to a 4-trillion-yuan stimulus package. China is expected to be a growing market but cannot alone support the global economy permanently.
Mr. Kazuto Uchida
Mr. Uchida: The recent crisis has clearly revealed differences of policies between Asian and European/American financial industries in respect of high-leverage fund raising, initial credit investigation and commoditization of credit risks.
It should come as no surprise that the commoditization of credit risks has not spread in Japan because Japanese financial institutions have achieved stability as a result of overcoming the bad debt problems, focusing on the retail businesses based on commercial banking in raising funds, placing great importance on customer relationship management and from other reasons. Japanese financial institutions may be slow in accommodating big structural changes but boasts a high level of stability.
Mr. Oyama: European and American financial institutions may have overestimated their risk management technique, resulting in underestimating those risks that cannot be measured. Asian financial institutions, on the other hand, assessed risks based not only on measurement but on comprehensive aspects, enabling them to have control over securitization and leverage. It does not necessarily mean that Asian financial institutions were more competent. We cannot also deny that some authorities in European and American countries had taken ineffective approaches.
Mr. Ariyoshi: The recent crisis has proved that those approaches which focus heavily on an internal risk assessment models do not work successfully. We should put greater emphasis on how to restrain systemic risks. We should not draft regulations on the basis of individual cases but should achieve consistency among relevant regulations worldwide. In addition, it is important not to prevent innovations with regulations. It is expected to design a structure where the banking businesses are not hindered while maintaining stability.
Mr. Uchida: Under macro-regulations, strengthening macro prudence as well as authorities in charge of regulating the financial sector is required. Although issues such as dynamic provisioning or enhanced capital adequacy ratios are under discussion, it seems to be sufficient to provide adequate loan loss provisions under normal credit management. We should not lean towards a capital-focused perspective.
We should also "manage" liquidity risks thoroughly but at the same time should "regulate" them prudently. Regulating liquidity on a country or currency basis may cause separation of financial markets and restraints on liquidity, thereby hampering liquidity or dynamism of global financial systems. Moreover, it will adversely affect cross-border businesses in Asia.
While achieving financial regulatory consistency across the world is important, we should not constrain other businesses in the real economy by giving priority to regulation of the financial sector. Given that each country has its own tax system, accounting standards or corporate culture, some aspects should be left to the discretion of each country.
Mr. Tsuyoshi Oyama
Mr. Oyama: Problems arise when there is a huge gap between the complexity of financial institutions' businesses and the competency of the authorities which supervise such businesses. The U.S. is trying to reduce the complexity or gap rather than to improve the competency of the authorities. However, it is not reasonable to take a similar approach throughout the world. In Japan, such complexity is lower compared to European or American countries, and the central bank is managing liquidity successfully. In such circumstances, it is not always necessary to follow the global trend in developing regulations.
Mr. Luo Ping: The global reform of financial supervisory systems provides us with a good opportunity to review the supervisory system of the banking sector. China will strengthen firewalls under the Chinese version of Glass-Steagall Act (a separation between commercial banking and securities industries).
Having learned a lesson from the subprime mortgage crisis, our country is now planning to introduce stricter standards for underwriting mortgage loans under which buyers are subject to stricter conditions such as requiring them to prove their income through a face-to-face interview or prohibiting securitization of home equity loans or low-quality assets.
Chinese corporations may become more cautious in expanding their overseas business such as M&A. It will be important to consider banks' organic growth.
Mr. Luo Ping
Mr. Luo Ping: In the aftermath of the recent financial crisis, China Minsheng Baking Corp., Ltd. ("CMBC"), ranked 7th in China, recorded a loss of 1,300 million dollars due to a subsidiary of UCBH, a California-based bank in which CMBC invested, being shut down by the U.S. authorities. Similarly, 60% of overseas M&A engaged by Chinese corporations have failed.
With this tough experience, China will take a cautious stance in expanding into overseas markets, particularly in M&A of non-bank companies. What matters is that banks themselves should develop their own organization.
Mr. Ariyoshi: In Asian countries, banks are generally the pillar of their financial systems. It would be unfortunate for Asia if the reforms to the financial systems would eliminate or restrain momentum in developing securitized products or entire capital markets. Asia will need to increase investments over the medium term and raise its growth potential, and a financial system that realizes it is required.
Mr. Uchida: The year 2010 will see accelerated regional economic cooperation and free trade in Asia where movement of goods, people and money will rapidly become active, particularly with China and India as centers.
Under such circumstances, although it may be inconsistent with the Glass-Steagall Act, establishing an Asian version of a CIB (Corporate Investment Banking) model based on thorough loan management and customer relationship management will bring about major growth.
It is also essential to stimulate primary and secondary bond markets in order to circulate the affluent savings of Asia. There is room for Japanese banks to contribute by issuing bonds smoothly in local markets. It is also an option to design a scheme under which funds are raised on a cross-border basis in Hong Kong or Tokyo where many institutional investors gather.
Increased spending by the middle-income class and growth of small and medium-sized companies are expected especially in China. Taking this opportunity, Japanese financial institutions can introduce its financial scheme for small- and medium-sized companies and know-hows of consumer finance into Asian markets.
Mr. Oyama: Unlike European and American countries, views of Asian countries are often ignored by the world. If Asian countries are united, it will generate advantages in having their opinions heard in making global rules. Japanese financial institutions should take the initiative and enhance collaborative relationships among Asian countries.
Marginalization of the Japanese economy is inevitable and it is assumed that we will not be able to regard Japan as a major economic power in the future. When considering whether Japanese financial institutions can do businesses in such circumstances, it will be critical for them to survive in Asia or global markets and they will face a crucial moment in the next 10 years.