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Tsinghua University School of Economics and Management


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Title: Tsinghua University School of Economics and Management

Tsinghua University School of Economics and
  • Lecture 2
  • Financial Stability and Bank Regulation
  • Andrew Sheng
  • Adjunct Professor, Tsinghua
  • September 19 2008

  • Structure of Financial Markets
  • What is Financial Stability?
  • What is Financial Regulation?
  • Pick Important Problems, Fix Them and Tell
  • Concluding Remarks

Finance is a derivative of the Real sector
  • Financial Sector intermediates between the
    various parts of the Real Economy - corporate,
    government, households and foreign.
  • Derivatives are useful because-
  • They help make immovable property divisible
  • They lower transaction costs
  • They permit leverage (higher profits)
  • BUT they carry higher risks and are not
  • Most banking crisis start with bad assumptions-
  • 1970s - corporate loans are good
  • 1980s - Governments do not fail (Latin America)
  • 2000s - Consumer credit is good
  • Financial stability relies on real sector
    stability, plus good risk management and

The Network Economy
The value of a network goes up as the square of
the number of users
Knowledge Content Branding
(Metcalfs Law)
Infrastructure e.g. utilities, communication
Quality of Information
NETWORK HUB Winner Take All Situation
Ability to stay ahead of competition
Economies of scale Critical Mass
Quality of Governance
Four Functions of Capital Market
  • Resource Allocation
  • Allocate resources efficiently to maximize
  • Price Discovery
  • Generate transparent price signals consistent
    with efficient use of resources
  • Risk Management
  • Encourage good risk management that diversifies
    losses and profits
  • Corporate Governance
  • Promote sound corporate governance that provides
    proper incentives.
  • Financial system is a system to transact and
    protect property rights of all participants over
    the whole demographic cycle!!!

Institutions of Capital Market
  • Accurate, timely and accessible information
  • Properly aligned incentives
  • Educated investor
  • Efficient intermediaries
  • Strong issuer
  • Efficient and robust infrastructure
  • Strong prudential framework with enforcement
  • We must understand nature of financial market in
    order to regulate it.

Micro-Elements of Institutional Building
Hierarchy of Financial Markets
  • Asset-backed
  • securities and
  • derivatives
  • Corporate bond and
  • equity markets
  • Government bond market
  • Treasury bill market and
  • foreign exchange markets
  • Money market

? Knowledge, Complexity, Risks
Multi-Tier Financial System
Bank loans
Risk transfer
Securities markets
Personal investment accounts
Production creation
Source Nomura Institute Capital Markets Research
  • Buy turn
  • Market depth and long term funding
  • Facilitate global allocation of capital
  • Dynamic
  • Mutual funds
  • Pension funds - defined contribution
  • Buy hold
  • Active traders and arbitrators/ proprietary
    trading desks
  • Banks

  • Seek high relative returns above benchmark
  • Breadth of investment objectives
  • Product innovation
  • Retail investors
  • Depth of investment capacity
  • Seek high absolute returns
  • Seek safe, predictable, average returns
  • Alternative Investors
  • Specialized funds
  • High net worth individuals
  • Investment bank
  • Pension funds -defined benefits
  • Employ variety of strategies to minimize risks
  • Match future liabilities with investment income
  • Insurance companies
  • Investment objectives
  • Examples
  • Role

Eight Global Trends
  • 1. The age of Capital Markets
  • 2. The age of Aging
  • 3. The age of Customer Value
  • 4. The age of Innovation
  • 5. The age of Risk and Regulation
  • 6. The age of Global Platforms
  • 7. The age of Consolidation
  • 8. The age of Realignment

Source McKinsey,2007
Key Capital Market Trends
  • Demographics around 300 million Asians earn
    US5,000 or more annually by 2020, discretionary
    spenders will grow to 1.4 billion. Huge demand
    for asset management and consumer banking needs
  • Wealth management - private banking spreading
    from those with US1 million or more to middle
    income professionals
  • Mutual Funds - in US already US7.5 trillion
    market, but becoming more leveraged no longer
    just long-only funds line between mutual funds
    and hedge funds blurred
  • Market makers - Asian investment banks still
    small by any standard
  • Outsourcing - over 100,000 jobs moved to India
    from US, worth US136 bn in wages trends will

The Global Financial Network
High Knowledge Content Good Branding
Key hubs usually efficient urban centres e.g.
New York London
High Quality Infrastructure
Real time Reliable Information
Pluralistic, Disciplined, Adaptive Good
Feedback Mechanism
Good Public Private Governance
Liquid Low Friction Cost
The Bretton Woods Architecture
  • International Monetary Fund, total quota
    (capital) of SDR217.3 bn (USD327.3 bn), 184
    members (March 2007 data)
  • World Bank (International Bank for Reconstruction
    and Development), capital US37.6 bn, assets
    US212.9 bn (March 2006)
  • Other IFIs include ADB, African Development Bank,
    EBRD, Inter-American Development Bank etc
  • Bank for International Settlements (BIS), owned
    by member central banks, equity of US18.2 bn and
    US410.5 bn assets (March 2007)
  • Total asset size of these institutions (US951
    bn) is trivial (0.5) compared with size of
    global financial assets of US190.4 trn and 2006
    gross capital outflows for emerging markets of
    US1,941 bn (IMF GFSR Table 1).

Post 1998 Architecture
  • Financial Stability Forum Central Banks,
    Ministries of Finance, IFIs, Standard Setters,
    Supervisory Agencies
  • Major move to incorporate Emerging Market views
  • Greater coordination of efforts of different
    implementation agencies, eg IFIs, Standard
    Setters (eg IASC, IOSCO, Basle Committee) and
    supervisory agencies also represented
  • BIS acts as secretariat to FSF, currently chaired
    by Mario Draghi (Governor, Bank of Italy)

Global Share of Capital Markets, 2006 US
trillion (IMF GFSR Table 3)
Global Assets Under Management (US trillion end
  • International Banking Assets (BIS data)
  • International debt securities 14.6
  • Insurance companies 13.5
  • Pension Funds 15.0
  • Investment Companies 14.0
  • Hedge Funds 0.8
  • Other Institutional Investors 3.4
  • Total 84.9
  • (2006 total (include direct holdings
  • US190.4 trn)
  • Memo OTC Derivative Contracts (notional)
  • (2006 total US415.2 trn, gross market value of
    U9.7 trn)
  • Source BIS, IMF

New Players in Global Financial System growing
fast US trillion

2000 2006E CAGR 2000-06E Pension
Funds 16.1 21.6 5 Mutual Funds 11.9 19.3 8 Insu
rance Funds 10.1 18.5 11 Petrodollar
assets 1.2-1.4 3.4-3.8 19 Asian central bank FX
reserves 1.1 3.1 20 Hedge Funds 0.5 1.4 19 Priva
te Equity 0.3 0.7 14 Source MGI, McKinsey
Global Institute Analysis
II. Weaknesses in Asian Financial
Markets Still a bank-dominated system
Asia still Dependent on Bank Financing ( of GDP)
Source World Bank Financial Sector Dataset,
February 2006
Recent Key Market Trends in Asia
  • Deposit-taking Institutions demographics
    changing customer pattern growth of consumer
    banking, credit cards, demand for structured
  • Risk-pooling Institutions - still foreign
    dominated, but demand growing
  • Contractual Savings Institutions - huge
    liquidity pools, but shortage of professional
    fund management skills
  • Market Makers - key investment banking skills
    still dominated by large foreign players, with
    foreign fund managers as key clients
  • Specialized Sectoral Financiers - policy-based
    banks shrinking in market size venture capital
    and private equity becoming more important
  • Financial Service Providers exchanges

Basic Reforms in Asian Financial Markets
  • Corporate Governance improved and de-leveraged
  • Banking system consolidated, with more foreign
    entry and supervision tightened (help of WTO,
  • Fiscal position improved, gradual removal of
    exchange controls and build up of reserve
    holdings to reduce risks of external shocks.
  • Exchange rates more flexible, but
    Samuelson-Belassa effect showing up in revival of
    asset bubbles, plus inflation. Real effective
    exchange rates are rising due to faster growth.
  • Asian financial integration increasing, but slow
    due to political and other differences.

Asian Domestic Financing Profile Equity
Financing (42) Overtook Money Financing (37)
in 2007
Source Asian Bonds Online
Still Lack of Depth in Many Asian Capital Markets
Source Exchange Collaboration and Joint
Operation in South-East Asia , McKinsey Co,
July 2007
Asia Half of World Population but Quarter of
Equity Market, 2006
Composition of World Population by Region
Composition of Global Market Capitalization by
Source IFS, and CIA World Factbook
Shallow Debt (Credit Bond) Financing in Most
Asia Countries (US billion)
Source Asian Bonds Online
Transaction Costs in SEA Equity Markets More Than
Double Those in US and Europe
Average Intermediation Costs (Money Market
Spread) in Asia is Relatively High (3.12, 2006)
Japan has lowest intermediation cost of 1.54 in
Intermediation Cost (Lending Rate Money
Market Rate)
Source IFS, IMF
III. Financial Stability Robust Real Sector
Robust Financial Markets Thinking through
how to regulate
Scope of Financial Regulation
  • What is Financial Regulation
  • Who do we regulation?
  • Why do we regulate?
  • How do we regulate?

Objectives of Financial Regulation
  • The goal of financial regulation is to influence
    the behaviour of intermediaries so that the
    policy objectives are achieved.
  • Regulatory Cycle
  • Policy Objectives ? Processes ? Policy Outcomes
    ? ? Policy Review
  • Regulation is more art than science, since market
    behaviour changes with time and innovation

Why Regulate?
  • Protection of investors - asymmetric
    information, unclear rules, and misconduct of
    intermediaries may lead to losses for investors
  • Risky behaviour of financial intermediaries
    could cause failure that either lead to contagion
    or financial crisis
  • Financial misconduct by issuers and
    intermediaries creates social loss and lack of
    market confidence on a level playing field

What is a Market?
  • People, exchanging
  • Products property rights, using
  • Process, e.g. trading, clearing, settlement
    software, across
  • Platform - hardware infrastructure/network
    carrying messages, under
  • Prudential Rules of the Game that protect the
    property rights.

Principal Features of Financial
Markets Identifying problems
  • People Are the people misbehaving?
  • Policy Is the policy wrong?
  • Products Are the products defective?
    property rights
  • Prudential framework Is the prudential framework
  • Platform and Process Is the process obsolete?


Efficient Markets require
  • Liberal Entry of Participants and Products
  • High transparency low information asymmetry
  • Efficient Operations by solvent participants
    under international rules of the game at low
    transaction costs
  • Low incentive distortions that moves market in
    unhealthy direction e.g. moral hazard or
  • Efficient regulation at low regulatory costs
  • Orderly exit of insolvent participants obsolete
    products and insolvent operators create huge dead
    costs on market

Source FSAP Experience and Issues Going
Forward, Stefan Ingves, Economic Forum, 16
December 2003
Types of Financial Regulation
  • PRUDENTIAL REGULATION ensuring that market
    participants have adequate capital and liquidity
    and are fit and proper (e.g. banks operate
  • CONDUCT REGULATION ensuring that market
    participants behave within ethical and statutory
    rules that does not impose harm on market (e.g.
    insider trading, connected lending)

Malcolm Sparrow - The Regulatory Craft
  • Pick important problems, fix them and then tell
  • The essence of the regulatory craft lies in
    picking the right tools for the job, knowing when
    to use them in combination, and having a system
    for recognizing when the tools are inadequate so
    that new ones can be invented.
  • Professor Malcolm Sparrow, The Regulatory Craft,
    Harvard University, 2000

Braithwaite Regulatory Pyramid
Each regulated group can be divided into
behavioural segments
Regulatory Response
Source Adapted from work of Prof. J.
Braithwaite, ANU
Policy, Process and Outcome
Regulation is Trade-off between Gains versus
Risks or Costs
  • Cost of Regulation
  • Resources spent to apply it Burden Imposed on
    Firms Law of Unintended Consequences
  • Benefits of Regulation
  • Reducing market failure and externalities
  • Preventing bad behaviour
  • Zingales necessary to do an overall calculation
    of the overall benefits of regulation versus its
    overall costs
  • Need framework to work out Policy Options
    Standards to measure costs and benefits

Luis Zingales, The Costs and Benefits of
Financial Market Regulation, European Corporate
Governance Institute, April 2004
To Reform or Not Reform
High incidence of market misconduct and fraud.
Impose more regulation to punish perpetrators and
deter future misconduct.
No market misconduct or fraud. Little or no
regulation required. Market and issuers exercise
Benefit of regulation lt costs of regulation
Dont reform
Benefit of regulation gt costs of regulation
Policy Option Matrix who gains, who loses?
Why do We regulate Banks?
  • Resource Allocation As the primary custodian of
    Public Savings, efficiency and stability of banks
    key to efficiency and stability of economy
  • Monetary Policy Banks are both the channels of
    monetary policy and operators of the payment
  • Risk Intermediary Banks have fundamental
    maturity and liquidity mismatches, prone to
    contagion and systemic collapse
  • Asymmetric Information Outsiders do not know
    how to assess bank quality
  • Consumer protection interface with retail at
    all levels
  • Competition To ensure innovation and no cartel

Bank Fragility Maturity Mismatch
  • Banks are fundamentally illiquid - they borrow
    short and lend long
  • The average maturity of bank liabilities (mainly
    deposits) can be less than 6 months, tending to
    zero when there is a bank run.
  • The average duration of bank loans are
    significantly longer (especially mortgages or
    corporate debt), because in times of crisis,
    borrowers delay repayment. Average duration of
    15-30 year mortgages is around 6-7 years
  • Hence, banks have to maintain high liquidity and
    there is a Lender of Last Resort function at
    central banks to provide emergency liquidity.
  • Banks must manage their liquidity better through
    securitization and asset and liability

Bank Information Asymmetry
  • Depositors and even regulators have difficulty
    judging quality of bank assets
  • Bank assets, especially long-term loans, are hard
    to evaluate as to value, due to illiquidity,
    valuation of collateral, solvency of borrower,
    real interest rates and market conditions.
  • Because banks are operators of the payment
    system, defaults of large customers can lead to
    their own defaults - settlement risks.
  • Banks are also highly leveraged

Banks are prone to Crisis (cost of resolution)
  • US Savings Loan failures (1981-3) - 5 of GDP
  • Scandinavia (4-11 of GDP)
  • Latin American (late 1980s and early 1990s)
    5-55 of GDP
  • Russia and Eastern Europe (early 1990s) - 5-10
    of GDP
  • Japan (15 of GDP)
  • East Asian crisis (21-55 of GDP)
  • SubPrime Crisis - US1 trillion?

Bank Regulation and Supervisory Process
  • Entry Licensing
  • Bank Regulation - Off-site surveillance, policy
    formulation and bank-regulator relationship
  • Bank Supervision or Examination - On-site
    Examination and Inspection to determine the
  • Determination of financial position and quality
    of assets and liabilities
  • Assessment of Quality of Corporate Governance,
    Internal Controls, Risk Management, and
    skills/experience and integrity of staff.
  • Exit - Orderly winding up through Deposit
    Insurance Scheme

Approaches to Bank Supervision
  • Self Regulation through bank associations and
    better corporate governance
  • Greater Disclosure
  • Prudential Measures - Capital Adequacy and
    Liquidity Rules BASLE I II
  • Corporate Governance
  • CAMELOT Ratings
  • Off-site Surveillance and On-site Inspection
  • Enforcement and Exit Processes

  • Capital Adequacy - meeting Basle requirements
  • Asset Quality - Loan Classification
  • Management Quality - fit and proper persons,
    corporate governance
  • Earnings Quality - ROE, ROA, cost ratios
  • Liquidity - Asset-Liability management
  • Operational Risk - how good are the operations
    and controls?
  • Technology - ICT management, infrastructure and

1988 Basle 1 Capital Adequacy
  • Weighted Risk-Asset Ratio, minimum 8 of risk
    assets, comprising two tiers
  • Tier 1 or core capital issued capital
    retained earning (minimum 4)
  • Tier 2 capital, including subordinated debt all
    other capital general loan loss reserves plus
    unrealized surplus on stock holdings by banks
  • Japan insisted that unrealized surplus on stock
    holdings by banks should be included as
    supplementary capital (this turned out to be
    serious mistake).

Basle II Capital Accord
  • Allows banks to use own models to evaluate risks
  • Three Pillars
  • Minimum capital requirements for credit risks,
    operational risks and market risks
  • Discretion to national authorities to fine-tune
    capital requirements
  • Greater disclosure and transparency.

Three-dimensional changes in Asias banking system
  • Asian banks have been substantially restructured
    since the 1997-98 crises.
  • Corporate sector disintermediation is accompanied
    by increased household intermediation.
  • Region has seen rapid entry of foreign banking

(No Transcript)
Significant changes in bank intermediation
  • Corporate sector is moving away from bank credit
    a process driven by large profits,
    de-leveraging and the growth of domestic bond and
    equity markets.
  • Banks are rapidly expanding credit to the
    household sector both cyclical and structural
    forces are contributing to this expansion.
  • Flexible exchange rates and interest rates are
    posing huge market risks for Asian banks,
    especially since they hold large amount of

Nature of Bank Losses
Credit losses Excessive regulatory fiscal
taxes Speculation Losses (Market risks)
Operational Risk losses (bad internal
controls) Fraud Excessive Overheads
(inefficiencies or incompetence)
Banking Crises and Resolution
  • Crisis is an event, the culmination of many
    factors interacting together
  • Bank restructuring and resolution is a process
  • Process involves four major steps
  • Diagnosis
  • Damage Control
  • Loss Allocation
  • Rebuilding Profitability and Getting the
    Incentives Right
  • How have we performed since Asian Crisis?

What is a Financial Crisis?
  • The eruption of an event (eg failure of a
    corporation or financial institution) that
    triggers a systemic distress, panic or wealth
    loss that spreads within domestic markets or
  • Crisis are caused by internal frailties or
    weaknesses that allow systemic breakdown as a
    result of internal or external shocks
  • Because financial system is a network, need to
    distinguish between liquidity crisis flow from
    solvency crisis stock
  • Banking system needs lender of last resort,
    precisely because Central Bank can step in to
    prevent a liquidity crisis from triggering a
    solvency crisis.

Stocks and Flows of National Economy
  • Financial system is blood circulation system of
    National economy. Financial network links the
    following four real sectors together
  • Corporate sector
  • Household sector
  • Public sector
  • External Sector
  • Each has its own balance sheet and flow problems
  • Crisis occurs when weaknesses in real and
    financial sector are exposed by event/shock in a
    vicious circle

1996 Negative Net Investment Position (NIP) and
Exchange Devaluation explains a lot about Crisis
Source calculations from Lane and
Milesi-Ferretti, 2006
Importance of Macro and Balance Shet Numbers on
Financial Stability US Flow of Funds data 2007
  • US External Position GDP 13.8 trn, Net current
    account deficit 5.1 of GDP, gross external debt
    13.4 trn (97 of GDP). Net International
    Position 2.44 trn or 17.7 of GDP (-22.6 in
  • Fiscal deficit 2.7 of GDP and debt held by
    public 36.6 of GDP. If Agency debt of 5.3 trn
    is added, total US Government debt would rise to
    75.4 of GDP.

US Current Account Deficit
How Bank Capital is Eroded IMF Article IV for
USA, July 2008
Balance Sheet of Households and Corporate Sectors
must be watched
  • Households Total Real Estate Assets 22.5
    trn, total financial assets 45.3 trn
    Liabilities 14.4 trn (mortgage 10.5 trn,
    consumer credit 2.6 trn, net worth US57.7 trn.
  • Corporate Total Real Estate US8.9 trn, Total
    Financial Assets US12.9 trn, Net Liabilities
    US11.3 trn, Net worth US16.1 trn.

Impact of Changes in Equity and Real Estate
Prices - 2007
  • Total stock market US16.9 trn (91 of GDP)
  • Total real estate (households corporate)
    US31.4 trn (228 of GDP)
  • If equity market falls 20, then losses would be
    3.4 trn or 24.5 of GDP.
  • If real estate prices fall 20, losses would be
    6.3 trn or 45.5 of GDP.
  • Decline in 1Q2008 for household net worth was
    1.7 trn, equivalent to 2.9 of total net worth,
    but 12.3 of GDP.

Impact on Financial Sector
  • Estimates from the Spring 2008 Global Financial
    Stability Report, using prevailing market prices,
    put losses at near 1 trillion globally and
    220260 billion for U.S. banksover one-third of
    the equity of the ten major commercial and
    investment banking groups. Of this, some 160
    billion in U.S. losses have already been
    recognized. - US Article IV
  • 2007, gross credit assets of US financial sector
    was 35.8 trn, of which capital of 4.6 trn or
    12.8 of assets (excluding derivatives).
  • Of credit assets, 14.1 trn was mortgages, 2.4
    trn was consumer credit, 10.2 trn was corporate
    bonds and loans, 6.2 was GSE and agency paper.
  • If credit losses exceed 15, capital of financial
    system would be wiped out.

Vicious Cycle of Financial Distress Asian
crisis private debt mismatches Latin American
crisis excessive public debt and inflation
Ultimately, Financial Crisis ends up as
quasi-fiscal deficit
  • Banks have implicit or explicit deposit
    insurance, ie moral hazard risks
  • Depositors or foreign creditors cannot absorb
    losses without huge political implications
  • Both banks or borrowers can be Too Large to
    Fail government is concerned that failure can
    have systemic problems
  • Hence, banks or borrowers transfer their stock or
    flow losses to the Government via Government
    guarantees, Asset Management Companies (AMC), or
  • Relationship is known as Troika model
  • NPLs and bank rescue trigger feedback effects in
    a vicious circle that destabilises monetary and
    fiscal situation, resulting in capital flight

Crisis have both Macro and Micro Origins
  • Poor macro policies, eg fiscal deficits,
    inflation, balance of payments deficits
  • Weak institutional structures
  • Lack of deep debt and capital markets
  • Lack of credit culture
  • Outdated laws, weak judicial systems
  • Poor corporate governance
  • Lax enforcement, poor risk management, connected
    or directed lending, weak loan recovery, deposit
    guarantees, and distorted tax policies all show
    up in weak balance sheets
  • Insufficient attention to Trade Cycle and Asset

How good is diagnosis?
  • Institutional strengthening
  • Coordinated surveillance by IFIs, FSF, FSAP
  • International standards set by BIS, IOSCO, IAIS,
  • Strengthened supervisory framework and
    cooperation at national and international level
  • Adoption and implementation of international
    standards by local networks would strengthen
    overall network, eg IAS, OECD corporate
    governance Codes, insolvency laws
  • Generally getting better at diagnosis, but
    informational difficulties remain
  • Asset valuation is difficult as there are no
    market prices for loans
  • Collateral valuation also serious problem in
    estimating provision needs
  • Inadequate provisioning due to tax changes that
    need reform
  • Banks generally reluctant to reveal extent of
    losses, unless forced by crisis or incentive to
    shift loss to AMC
  • NPL estimates by market vary and at least double
    official data

Damage Control
  • Because NPLs derive from real sector exposures,
    they can be minimized in two ways-
  • (a) Restrict further bank lending (quick fix)
  • (b) Work on changes in corporate governance and
    debt recovery (long haul solution)
  • You must stop both the stock and flow losses
  • Faster IFI response with better recognition that
    no one size fit all solution can apply
  • Selective bank closures or foreign entry helps to
    keep domestic banks on their toes
  • The fact that NPLs have been reduced in some
    economies does not mean that they will not revive
    if structural issues (eg poor borrower solvency,
    connected lending, weak corporate governance,
    policy distortions, political instability) are
    not resolved.

Loss Allocation
  • Political economy of loss allocation Who
    should bear loss shareholders, borrowers,
    banks, employees, depositors, external creditors,
    government? Ultimately, state bore most of losses
  • Liquidate or restructure banks market solution
    or government intervention? Mixed approaches
    closures, mergers, nationalisation, foreign
    investment and government bailouts
  • Key concern is fiscal sustainability since
    unresolved NPLs, as quasi-fiscal deficits
    increases contingent liability of budget and
    therefore become potential future tax burden

Fiscal Sustainability - inflation, growth and
  • Fiscal sustainability of debt, and hence success
    of bank restructuring, depends on rate of
    inflation, growth and level of budget deficit.
  • The change in government debt to GNP ratio (d)
  • Change in d (primary deficit/GNP)
  • d (real interest rate growth rate)
  • Low inflation, high growth and low fiscal
    deficits or small surplus economies will see d
    decline over time. E.g. Malaysia, Spain and
  • Large primary deficits and excessive real
    interest rates result unsustainably huge debt
    ratios, leading to hyperinflation. E.g.
    Argentina and Yugoslavia
  • Change in d also depends on whether NPLs are
    checked and bank losses stemmed

Building Market Economy means building a Robust
Property Rights Infrastructure (PRI)
  • 1. Delineation of property rights
  • Property rights need to be clearly defined and
    legally protected
  • 2. Enforcement of property rights
  • Property rights need to be protected and enforced
    efficiently, fairly, and predictably through
    independent judiciary and regulatory systems
  • 3. Culture in respecting law, property rights and
  • Credit culture means respect of law, property
    rights and contracts, and they are rewarded for
    doing so
  • 4. Reform market institutions that protect rights
  • The accounting, regulatory, judiciary and
    property registration (eg land and equity
    registration systems) need to brought up to
    international standards in order for markets to
    perform efficiently, fairly and transparently

Efficient Markets Have Robust PRI Institutions
  • Central Registry of property right e.g. land
    registry, share registry
  • Trading Engine e.g. stock exchange
  • Clearing, settlement and payment infrastructure
    clearing house and payment system
  • Regulated intermediaries
  • Clear Rules of Game norms, standards, codes,
    regulations, law
  • Enforcement infrastructure enforcement costs
    cannot exceed benefits to market
  • Independent and transparent judiciary to
    adjudicate property disputes
  • ? Effective judiciary, enforcers police,
    regulators, enforcement agencies, accounting,
    legal and financial intermediaries are all part
    of PRI

Process to Manage Reform
  • Asia has implemented many reforms, but outcomes
    may not always be on target.
  • Reform fatigue could have set in resulting in no
    follow through to ensure successful
  • Law of unintended consequences may frustrate
    reform efforts and generate reform resistance.
  • Reform is a process, but we need a process to
    manage the reform process so that it stays the
    course and departures from path can be put back
    on track through set procedures.
  • Reform needs ownership of the need for change.
  • Process to manage change is an important area
    that deserves more attention by policy makers.

Use Different Levels of Discipline
  • Self Discipline - self regulation, using market
    standards and codes
  • Regulatory Discipline - enforce fairly and
  • Market Discipline - use courts, competition and
  • All three disciplines are necessary to achieve
    good corporate governance and efficient markets

Getting the Incentives Right
  • Financial crime and bad intermediary conduct
    thrive when there is no regulatory credibility
    that they will be caught
  • Regulatory credibility depends on effective
    surveillance, speedy investigations,
    well-prepared prosecutions and appropriate
  • Justice must not only be done, but seen to be
    done there must be clear and transparent due
    process in investigation and the disciplinary
  • Enforcement Key to Regulatory Discipline

Sparrows 6 Themes of Regulatory Practice
  • Cut obsolete regulations
  • Reward results, not red tape
  • Get out of your office and create
    regulator-regulatee partnerships
  • Negotiate, do not dictate
  • Reduce regulatory reporting burdens
  • Search for results that count

  • Thank You
  • Address questions to as_at_andrewsheng.net
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