Lessons from the Global Financial Crisis for Asia
1. The U.S. sub-prime mortgage crisis in July 2007 has developed into a full-blown global financial crisis. The true depth and breadth of the crisis was realized in mid-September 2008 when Lehman Brothers declared bankruptcy, Merrill Lynch was taken over by Bank of America, and AIG applied to the Federal Reserve for emergency financial aid. The Wall Street crisis has since spread widely to other countries and markets. All the industrial countries and emerging economies, including Asian developing countries, were hard hit by the crisis, and have experienced economic recession, rising unemployment, deflationary pressures, a drastic fall in stock prices, credit crunches, liquidity shortage, and shrinkage of foreign trade.
2. The U.S. and other governments responded to the 2008-09 global financial crisis by reducing interest rates, injecting funds into banks, guaranteeing bank liabilities (deposits and debt) and even nationalizing banks as a means of stabilizing financial markets, stemming the risk of bank runs and capital outflows, relieving liquidity shortages, and restoring confidence in the financial system. In order to rescue the economy, governments worldwide have adopted economic stimulus packages including tax cuts and increases in infrastructure investments, with the hope that an easy monetary policy and expansionary fiscal policy would help speed up economic recovery.
3. Asian government policy makers, economists, bankers, investors, and the general public can learn a number of lessons from the background, causes, and responses to the crisis.
- Recognizing the factors contributing to the financial crisis including the long period of low interest, rising asset prices and abundant liquidity. We call on Asian bankers to resist the urge for higher yields through risk-taking. Mortgage finances should be carefully appraised, and real estate lending should be capped.
- We urge Asian banks not to lower credit standards and engage in riskier lending activities with maturity and currency mismatches (i.e. funding of long-term loans or investments using short-term deposits, or borrowing foreign currencies to finance loans denominated in the national currency). Heavy investments in property-related securities should be avoided.
- The ABA supports the continuing practice of sound banking principles and better risk management in order to achieve an appropriate balance between return and risk. The build-up of excessive leverage by financial institutions is risky and unmanageable.
- Market discipline proved weak in many crisis-hit countries due to inappropriate accounting rules, complex securitization structure, inadequate disclosure, lack of transparency, poor bank governance and excessive compensation arrangements. The crisis provides an opportunity for Asian banks to review and improve market discipline in order to prevent future banking crisis.
- The crisis has intensified the debate on the adequacy and effectiveness of Basel II. The ABA sees the need for Asian banks to accumulate enough capital during good economic times in order to be prepared for a soft landing during bad economic times. We urge the Basel Committee on Banking Supervision and the Bank for International Settlements to reassess whether greater capital adequacy and tougher rules on credit exposure may be required for banks.
- The complexity and opacity of securitization makes it difficult for banks and investors to assess the risks involved. The creation and purchase of credit derivatives such as mortgage-based securities (MBS), collateralized debt obligations (CDO) and credit default swaps (CDS) must take into account asset price movement, leverage, and systemic risk. There should be less dependence on optimistic statistical analyses by credit agencies and more reliance on one’s own due diligence.
- One of the important lessons from the crisis is the need to ensure sound financial innovation and effective financial regulation and supervision. Following financial liberalization and globalization, financial innovation has boomed. However, financial regulation was not equipped to see the risk concentrations and flawed incentives behind the innovation. As a result, regulators cannot adequately address the problems and risks arising from financial innovation, within the existing legal framework.
- The deregulation and removal of the firewalls among banking, insurance, and securities with no corresponding integration of fragmented financial supervision leave room for arbitrage. The unification of financial regulation and supervision has already taken place in several Asian countries. The U.S. government is proposing a sweeping overhaul of the financial regulatory system. The Federal Reserve will be granted new authority and accountability for regulating bank holding companies and large financial firms, in order to more closely monitor systemic risks. For Asian countries, the ABA proposes a rethinking of institutional arrangements for financial regulation and supervision.
- We propose that the perimeter of financial regulation and supervision be extended to cover investment banks, hedge funds, private asset pools, mortgage brokers, credit rating agencies and securitization vehicles. They have been lightly regulated or generally not supervised prudently by financial supervisory authorities. Failures of these businesses can cause financial instability, so they need to be closely regulated and supervised.
- There is a clear need for international cooperation to coordinate fiscal and monetary policies, to deal with troubled financial assets, and to rescue failing banks. Efforts should be exerted to strengthen the mechanism of information sharing, joint risk assessments, liquidity support, pooling of funds, and currency swap arrangements between national regulators. International cooperation in financial cooperation is important and urgently needed to prevent or mitigate international financial crisis.
- We encourage the establishment of an early warning system for financial crisis. At present, the warnings are too scattered and unspecific to attract policy action. The concerned international organizations (the World Bank, the IMF, regional development banks), economists, financial experts, and national financial regulators are urged to develop an early warning system. This system would allow the authorities to take appropriate action immediately prior to a crisis, with the aim of preventing future ones.
30 October 2009, Manila