Strategy for the "known-unknown": BOT Governor

business July 09, 2012 00:00

By The Nation

4,625 Viewed

At Sasin Bangkok Forum, Bank of Thailand Governor Prasarn Trairatvorakul expressed his concerns over "known" and "unknown" factors that are influencing the global economy as well as the Thai economy.



 

 
 
 
 
 
In his speech delivered today entitled "Financial Crisis and the Future of Global and Asian Banking", he highlighted the strategy for the "known-unknown" and stressed that such would be successful with 3 critical factors - coordination  of regulators, commitment forged by inclusiveness, and communal responsibility to restore market mechanism as a pillar of governance and financial discipline. 
The following is the full speech: 
 
Good morning.  It is an honor to join all of you today.  I would like to thank 
Sasin for organizing this forum and for inviting me.  Over the past three decades, 
Sasin has played an important role in grooming business and policy leaders who 
have been instrumental in building Thailand’s open and competitive economy. 
Today, we are facing another critical juncture for Thailand and the global economy. 
This forum has brought together the world’s leaders in public policy, businesses, as 
well as academia, and is therefore a rare opportunity for dialogue on our strategy 
going forward.   
Ladies and gentlemen, 
This brings me to the topic of my remark today. The future of banking 
industry at the global level and in Asia is being shaped by three major forces, 
namely, the fragile global economy, global financial regulatory reforms, and the rise 
of Asia which faces its own developmental challenges.  These forces are interrelated 
and complex, no one can claim to fully understand the final outcome.  So is this the 
new paradigm of known-unknown?  That is, we know what the major drivers of 
change are, but we cannot forecast outcome.  So the key strategic challenge is how 
to deal with Known-Unknown.For the short-term, the key priority is dealing with the fragile and volatile 
global economy. Stability is the priority for banks and regulators.  The strategic 
policy question is how to get the right balance between risk and return, stability 
and growth.  Weaker banks will retrench, leaving rooms for the few stronger banks 
 
to take up market share.  In Asia, we have seen banks from the Asia-Pacific, notably 
Japanese, Chinese, and Australian banks moved into market space where European 
and U.S. banks have retracted.  ASEAN banks are also shifting strategy to play a 
greater role to support their conglomerates in the regional expansion.  If this regional 
banking trend continues, what are the implications for banks, regulators, and central 
banks? While the region has so far remained relatively resilient to the first round 
impact of European bank deleveraging, there is significant concern about the second 
round impact through the slowdown in global trade and economy that will impact 
growth.
 
Another known-unknown in the short-term is the impact of interaction of 
various traditional and non-traditional policy measures, such as monetary 
policy, prudential policy including macroprudential. As a result of this crisis, the 
acceptable policy space has been significantly widened, for example, 
macroprudential policy now includes sectoral measures such as those to prevent 
property bubbles or to control adverse impact of capital flows.  While these 
measures have merits in safeguarding financial stability, they could have complex 
and cross-border impact.
 
 
Even on the monetary policy front, unconventional measures are becoming 
more conventional. Central banks in the major economies have increasingly used 
unconventional monetary easing. Though necessary to stabilize their economies at 
this juncture, these policies have side effects of large and volatile capital inflows into 
Asia. This further complicates safeguarding of financial stability in other countries 
including Asia, and could, in turn, trigger some countries to resort to 
macroprudential measures themselves. 
Thus, in terms of policy space, we are dealing with a new paradigm of 
expanded policy tools, with new transmission mechanism, and requiring their own 
policy framework and governance. So we need to recognize the need for  crossborder coordination as well as flexibility in execution given emerging 
uncertainty.
 
Turning to the more medium-term structural issues,  major regulatory 
reforms especially Basel III, Financial Stability Board reforms, and DoddFrank Act are still a known-unknown.  We do know that they are designed to 
redress weaknesses that caused the crisis by enhancing capital and liquidity, while 
addressing the problems of procyclicality, and too-big-to-fail of SIFIs.  For this, 
their merits are well recognized.  But these reforms will reshape the global financial 
landscape and raise cost of financial intermediation. They will also have 
implications for cross-border level playing field, regulatory arbitrage, and alter risk 
profile of banks.  Therefore, we need to recognize the unknown element, that is, we 
don’t know their full impact on the financial market and global economy.  
 
The latest review of the Financial Stability Board of potential unintended 
consequences of regulatory reforms pointed to these concerns.   Emerging 
markets have raised some concerns about the  Basel III capital and liquidity 
frameworks.  These may have negative impact on domestic financial markets, 
increase banks’ cost, and thus reduce credit and financial market liquidity.  In 
particular, the liquidity standard, which is not yet finalized, the calculation in the 
framework may not accurately reflect emerging market’s financial market, and the 
implementation could distort local financial market. There have also been concerns 
about the treatment of traditionally low-risk trade finance in leverage ratio which 
may impact growth and development.  Emerging Asia is predominantly bank-based; 
thus, Basel III will affect its financial intermediation relatively more than in the 
West, just at the time when financial intermediation is critical to support economic 
development and integration. Some of these standards are still under discussion, and 
thus Asia-Pacific region already has a proactive regional strategy to help steer these 
regulatory reforms, such as through EMEAP forum, to reflect our economic and 
financial market context.  With regard to the  OTC derivatives reform which aims to move  OTC 
derivatives trading on to exchanges and cleared through central counterparties. There 
are concerns regarding inconsistency of regulation between countries, infrastructure that is needed, and cost for users. For example, if national central counterparty is not 
a viable and efficient model for a small economy, then the cost of hedging would 
increase with higher risk weight under Basel III. Meanwhile, if derivatives are 
cleared overseas, through regional or global  central counterparties, we need to 
consider implication for  cross-border supervisory coordination, financial stability, 
and development of local financial market and competition.  On a related issue of
Dodd-Frank Act, restriction on proprietary trading of US bank could impact the 
liquidity of US dollar markets abroad, as well as liquidity of foreign government 
bond markets which are the back-bone of their monetary policy operation.
 
Another key issue going forward is the balance of authority between Home 
and Host regulators. There are concerns about the proposal of Financial Stability 
Board on cross-border resolution of Global Systemically Important Financial 
Institutions, or  G-SIFIs. The concern is that some Host regulators may not be 
included by the Home regulator in the Crisis Management Group or resolution 
planning, even if the institution is systemically important in their jurisdictions.  
We are glad to see the FSB taking initiatives to identify potential problems.  
Now it is the time to work together on solutions in an inclusive manner. This is 
because the inclusiveness of the process assures acceptability and commitment, and 
reduces the uncertainty from unilateral action of individual countries.  These 
international regulatory standards have no direct international enforcement power.  Before the global crisis, the governance is based on discipline which came from the 
market discipline, but now market discipline has diminished. Also the influence and 
discipline from the IMF program or FSAP may have been somewhat countered by 
growing importance of regional financial assistance mechanism with their own 
governance.  Each country or region would be more likely to adopt these new 
standards if they buy-in to the rationale of the reform.  Inclusiveness and 
coordination are therefore keys for commitment, and the pillars of the new 
governance for bodies such as the Basel Committee and Financial Stability Board; 
this is perhaps the new Bretton Woods. 
 
 
 
Turning to longer-term challenges and strategy, Asia’s increased economic 
importance will rise as a consequence of its development efforts in liberalizing the 
economy and the financial system, allowing market forces to enhance efficiency and 
productivity.  These forces will accelerate with increased integration of the ASEAN 
Economic Community, ASEAN plus 3, and plus 6.  
For intra-Asia’s financial flows, Asia is not “homogenous”  – the “North 
Asia” and financial center economies are developed, and some are mature 
economies facing their own challenges.  The rest of Asia is emerging economies, 
some facing middle income trap, and some facing the transition challenges from 
centrally planned to market economy.  “North Asia” will tend to have savings 
surplus, and need growth potential and to export of FDI.  “South Asia” will need 
savings to finance investments.  There is a natural synergy in resource allocation,
industrial and logistic linkage.  Thus, regional financing and growing role of 
regional-centric financial services would naturally follow.
The most critical challenge emerging Asia faces is to build economic and 
financial infrastructure fast enough to properly harness the growth energy and 
put these capital into productive use.  Without adequate financial infrastructure, 
namely market and legal infrastructure, and financial literacy, there is potential risk 
that emerging Asia cannot absorb such flows. This could result in misallocation of 
resources, including asset bubbles and instability. In parallel, public investment in 
infrastructure projects, as well as social investments in education and healthcare, are 
keys for increased productivity and economic upgrade. The challenge lies in getting 
the right balance between growth and stability, in managing large and long-term 
financing, increasing public investment, while keeping financial discipline. 
These are complex issues on how to ensure efficient resource allocation.  
A key strategy is to enhance the role of the market mechanism of the financial 
sector in Asia to rise to the challenge, and to act as check-and-balance on public 
policy.
 
In closing, we are at an important turning point where we face paradigm shift. 
This is one of the realignment of relationship between the market, regulators, and 
society. In crisis countries, the balance of the relationship between the financial 
industry and the society shifts because the cost of financial crisis is born by the 
society.  In emerging Asia, public policy including financial regulation comes under 
pressure from social demand for financial access as well as consumer protection. 
These naturally accompany the take-off in growth as a result of economic and 
financial liberalization.  
Both banks and regulators need a proactive strategy to deal with social and 
political environment that will shift banking environment and regulatory paradigm.
Thus, the strategy for banks going forward must also include proactive governance 
and accountability framework that seeks to restore trust in market mechanism, 
and improve the social and political environment in which they operate. Failing 
to recognize the powerful social forces will result in less than optimal regulations.  
Similarly, the strategy for successful global regulatory reform is to assure an 
inclusive process, to garner commitment and credibility for the reform. 
 
In concluding, the key strategy for dealing with this paradigm shift of knownunknown is based on 3 Cs. Coordination to deal with our interconnected financial 
stability. Commitment forged by inclusive global reform process. And, Communal 
responsibility, or governance, that can regain trust of society in market mechanism, 
so that we can rebuild market discipline as a key governance and pillar of the 
financial system. These are our best hope for striking the right balance between risk 
and return, growth and stability, and regulation and market discipline at a time of 
known-unknown.
Thank you for your attention