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Strategy for the "known-unknown": BOT Governor

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


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