Date: 12 May 1998

INTRODUCTION

1   I am happy to welcome you to this seminar jointly hosted by the World Bank's Economic Development Institute and the Monetary Authority of Singapore. The topic of the seminar is one that concerns all of us. Asia's recent experience highlights the vital importance of banking and financial system soundness to economic growth and development. What began as speculative attacks on a few regional currencies quickly became a full-fledged banking and financial crisis, and then escalated into an economic crisis with widespread ramifications. The momentum of three decades of almost uninterrupted growth has been thwarted by weaknesses stemming in large part from the financial sector.

WHAT CAUSED THE CRISIS?

2   The crisis engulfing the region was caused by a complex interplay of factors, including investor panic and volatile fund flows on financial markets. But the problem also reflected fundamental weaknesses in the regional economies. These weaknesses can be grouped into three categories: macroeconomic, microeconomic and institutional.

3   At the macro level, those countries that were worst hit by the crisis had inflexible exchange rate systems. They maintained parity with the strong US$ even as their exports were slowing down and their competi-tiveness was being eroded. Widening current account deficits disquieted investors. When they withdrew their funds, it sparked off a downward spiral in the regional currencies.

4   From a microeconomic perspective, fixed exchange rates led financial institutions and private corporations to expect that governments would maintain these rates, and that they could safely accept large foreign currency exposures without hedging them. Deregulated capital markets enabled local banks and corporates to borrow heavily from abroad. To compound the problem, local banks then extended loans based on personal relations or political connections rather than the commercial viability of the projects.

5   The third set of weaknesses was institutional. Governments had liberalised their financial sectors without adequately strengthening regulatory and supervisory systems. Market discipline could not operate effectively because of a lack of transparency. Inadequate information also caused investors to fear the worst and over-react amidst uncertainty.

HOW DO WE REDUCE THE RISK OF FUTURE CRISES?

6   What can we learn from the current crisis?

7   First, governments must pursue prudent fiscal and monetary policies to ensure sound macroeconomic fundamentals. This is crucial for restoring investor confidence. Credible and sound policies rather than quick fixes will provide a more enduring basis for a healthy and stable financial system.

8   Second, bank regulatory and supervisory systems must be strengthened. As markets open up and competition intensifies, banks will be tempted to expand their market shares by offering looser credit. Bank regulators need to promote prudent lending practices and ensure that banks are adequately capitalised to meet adverse contingencies. In addition, they need to ascertain, through on-site inspections, whether financial institutions have proper internal risk management controls.

9   There is also a growing consensus that financial reforms need to be properly sequenced. Domestic institutions need time to adapt to a more competitive environment and larger capital flows without assuming too much risk. Regulators need to build up their capabilities to cope with an enlarged supervisory role.

10   Third, there must be greater disclosure and transparency. This will help reduce the likelihood of market over-reaction arising from lack of information or information asymmetries. Greater transparency in the financial sector will also help foster market discipline, and prevent resource misallocations stemming from transactions based on political or familial connections.

11   Greater transparency can be achieved on several fronts. These include raising bank disclosure standards, improving corporate gover-nance, providing more information about the government's policy framework, and releasing economic and financial data in a more timely and regular fashion.

12   Fourth, Asian countries must develop deep and broad capital markets, and rely less on the banking system for financial intermediation. Capital markets provide a better maturity-match between the sources and uses of funds than bank lending. Where funds are raised largely through capital markets, financial systems become less vulnerable to fluctuations in short-term capital flows. Fundraising through the capital markets also encourages corporations to be more transparent and promotes market discipline.

LESSONS FOR SINGAPORE

13   These lessons for the future apply as much to countries like Singa-pore, which have been less affected by the crisis, as they do to countries directly affected. With globalised markets, no economy is immune to contagion. The steps that the distressed economies need to take are measures that no economy, however sound, can afford to ignore. Singa-pore may not be as lucky the next time a financial crisis erupts. We are therefore taking to heart some of these lessons and striving to strengthen our systems and put in place mechanisms that will minimise the risk of financial distress.

14   For example, the crisis has reinforced our awareness of the need to manage financial reforms in a controlled and orderly manner. The Monetary Authority of Singapore (MAS) is committed to opening up the financial sector to more competition and allowing market participants more free play to innovate and take risks. But we will undertake these reforms through a steady series of incremental changes rather than in a "big bang" so that there is time for institutions and participants to adjust and adapt.

15   A lighter touch to regulation will not mean a slackening of supervisory vigilance. While playing a more active role in promoting the financial industry, MAS will be boosting its on-site examination capability significantly. By conducting inspections more regularly and covering more financial institutions, we aim to detect problems early and recommend corrective actions in a more timely fashion.

16   At the same time, we will move towards a more disclosure-based regulatory system and promote greater transparency in the market. A private sector committee is currently studying ways to raise bank disclosure standards. For its part, the government has encouraged the banks to provide more data and information on their bad debts and their exposure to the regional countries. The banks have already done so this year, and their disclosures have been well received by investors. Far from the bad news spooking markets, the candour and openness has boosted confidence that problems will not be swept under the carpet, or allowed to fester.

CONCLUSION

17   Despite our best efforts, we cannot completely prevent banking and financial crises from recurring. They are an inevitable feature of open capital markets. But sound and credible policies can minimise the probability of such crises and build resilient financial systems to withstand them when they do occur.

18   The current crisis has forced many of the East Asian economies to undertake a fundamental review of their banking and financial sector policies. The international community can help in this process. For example, the IMF and World Bank can advise on macroeconomic policies and financial sector reform. Organisations like BIS and IOSCO can provide technical assistance in improving supervisory systems. If the countries in the region are committed to reforms and the international community is supportive, East Asia will emerge stronger and more dynamic from the crisis.

19   I wish you fruitful deliberations.