THE world is lurching from one crisis to another. In 2007 it was the Great Financial Crisis that led to the Great Recession. We were pulled out of the abyss through worldwide massive fiscal pump priming and historic monetary easing.
Little, if any significant reforms of the international financial structure, beyond tinkering with Basle III, were introduced, let alone implemented. One of the consequences of these policies, commission and omission, was the rolling bubble. The bursting of the financial bubble in the US was followed by the financial bubble in Europe.
Banks, particularly European banks are haemorrhaging from massive sovereign and private loans that were given to the peripheral and semi-peripheral countries of the European community.
Similarly, Asia was hit by a serious financial crisis in 1997. The failure of the global financial institutions to address the problem prompted Asian countries to work for greater monetary and financial cooperation. But the conditions are not conducive for such an integration.
Also, the problems confronting the European Union give cause for caution and present an opportunity to learn from positives and negatives of the Union’s experience.
While the conditions for Asian monetary union are not conducive, efforts at monetary cooperation should proceed on three fronts — exchange rate co-operation, co-ordination of capital flows, and coordination and strengthening of regional financial liquidity management.
The advantages of the local currency bond markets are well-known but there is need to highlight the risks and downside, namely foreign exchange volatility, macroeconomic instability, non-inclusive financing and pro-cyclicality. Focus should be on the other institutional financing structures namely regional and national long-term credit/development banks that can reduce instability associated with capital markets while addressing problems of currency and maturity mismatch as well as pro-cyclicality and non-inclusive financing.
In the area of financial integration, the main thrust has so far been to develop and deepen capital markets in particular, the bond market , as a means to recycle regional savings for regional investment. In developing the financial structure, too much emphasis has been laid on developing capital markets without considering the attendant risks and costs.
There is a trade-off between liquidity of capital market and financial and economic stability in host countries. Liquidity is mainly for investors and brings with it volatility of capital flows with negative macro-economic effect.
More serious consideration should be given to a develop a third leg of the financial system i.e establishment of regional and national long-term credit banks that are able to avoid the problem of double mismatch while minimising the costs of speculation, volatility and instability.
The proposed difference is that these banks should not adopt the economic value-added model of business but one that accepts a socially accepted rate of return. Financial institutions over the past few decades, operating in an environment of deregulation and liberalisation, have made profits that are disproportionate to other sectors of the economy. This has heightened financial fragility and instability that is not sustainable.
On the other hand, several regional and development banks that have been prudently managed have performed well over the Great Financial Crisis. It is time to explore models of financing and business other than maximisation of shareholders value.
New Business Model: Many Asian countries are flushed with foreign exchange reserves that are not only well utilised and also cost ineffective. These countries should consider setting aside a percentage of their reserves to fund one or several regional development bank(s).
As sovereign investors, they should take a long-term view to promote stable economic growth (b) adopt a professional and hands off approach in evaluation of credit worthiness of projects and of their social contributions (c) they should not follow the market fetish of economic value model that seeks to maximise the rate of return to shareholders at the expense of all other stakeholders.
The prevailing business model – the dominant paradigm –is unsustainable and generates considerable social costs. The limitation of this business model is beginning to be questioned by not only some business academicians but also some prominent businessmen worldwide.
Extracts from a research paper on ‘Asian Initiatives at Monetary and Financial Integration’ by Mah-Hui (Michael) Lim and Joseph Anthony Y. Lim. Courtesy: South Centre, Geneva